One of my favorite subjects involving investing are the intellectual errors we humans engage in on regular basis. Most of these foibles are built into our "wetware." The combination of evolutionary developments and our natural tendencies to seek pleasure and avoid pain have led to certain behavioral patterns that undermine our best efforts as investors. As we pointed out in Know Thyself, when it comes to investing, we humans just ain’t built for it.
Whenever I get questioned on that, I refer to Thomas Gilovich’s book "How We Know What Isn’t So." Gilovich, a psychology prof a Cornell, details many of the cognitive errors we unknowingly engage in. People regularly push back on this, believing they are rational (or mostly rational) and are free from preconceived biases.
This is, of course, utter nonsense.
I often come across non-investing examples of how much of our behavior is hardwired and chemical, and where we engage in unconscious automatic tendencies. Our behavior is impacted by factors which we are wholly unaware of. While this may not appear to directly correlate to markets and trading, they indirectly show how easily our brains can be fooled.
A fascinating example I came across recently this involves food, diet, and how we eat. Typical diet plans focus on what we eat: fat content, calories, quantity, and exercise (Note that the diet industry is estimated to be $40-100 B per year). It turns out our brains regulate our food consumption in ways we are not conscious of. Often, environmental cues will influence our food intake.
Brian Wansink (also of Cornell) has been called the "Sherlock Holmes of Food." He is the director of the Cornell University Food and Brand Lab, and is the author of Mindless Eating: Why We Eat More Than We Think. Wansink claims that our minds make more than 200 food-related decisions a day — most of them without any actual thought.
It turns out the circumstances of consumption greatly impact how much we consume. Consider these example from Wansink and Mindless Eating:
Container size influences how much we eat: Moviegoers given five-day-old stale popcorn still ate 53% more if it was served in a big bucket than a small bucket.
Size of a serving bowl, a plate, or a package has repeatedly been shown to bias how much a person serves himself and eats by an average of 20-30%.
Glass Shapes: Because of visual illusions, people (even bartenders) pour 28% more liquid into a short wide glasses than tall ones.
We eat more if we like what we’re drinking: In one study, diners drank the same wine but 1/2 were told it was from California, and the other 1/2 were told it was North Dakota wine (No, ND does not make wine). Those who thought they were drinking California wine ate 11% more food.
Bulk Purchases: 50% of the snack foods bought in bulk (such as at a warehouse club store) are eaten within 6 days of when it is purchased (Wansink and his Food and Brand Lab have been credited with the discovery of the 100 calorie packs)
Names of a food can create either positive or negative predispositions that can unfairly bias a person’s perceived taste of a food.
Self Service: A person will eat an average of 92% of any food they serve themselves.
We don’t pay attention to the extras: 31% of people leaving an Italian restaurant couldn’t remember how much bread they ate; 12% of the bread eaters denied having eaten any bread at all.
We eat more if the evidence is removed: In a study of chicken-wing eaters, waitresses removed the bones from half the tables while letting them stack up on the other half. The diners who still had piles of bones on their plates ate 28% less.
Too much variety makes us overeat: Snackers were given bowls of M&Ms with either 7 or 10 colors of the candy. Snackers with 10 color options ate an average of 43 more candies than those with just 7 colors to choose from.
Proximity of candy on one’s desk has been shown to double how much a person eats over the course of a day
Friends make you eat more: You’ll eat 35% more dining with a friend than when eating alone. Even worse, a person will double the amount of food ingested when dining in a group of 7 or more.
Eating fast makes you consume more calories: Consider this University of Rhode Island study on diet: researchers showed the speed at which we eat influences caloric intake. Faster eaters consumed on average 67 more calories then when they ate slowly. That’s about seven pounds of per year. (People also reported feeling more full after eating slowly).
What does this have to do with markets and investing?
It turns out, a whole lot. Many of our behaviors and belief systems are based upon elements we are wholly unaware of. We believe in myths, make false assumptions, overtrade, and engage in many investing behaviors that are destructive — most of the time completely oblivious to them.
Investors are well served if they become aware of these tendencies — and take steps to avoid fooling their own brains.
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Source:
Brian Wansink
John S. Dyson Professor of Marketing
http://aem.cornell.edu/faculty_content/wansink.htm
Food and Brand Lab
Cornell University
Department of Applied Economics and Management
http://foodpsychology.cornell.edu/
Latest Weight-Loss Advice: Slow Down and Pay Attention
TARA PARKER-POPE
WSJ, January 16, 2007; Page D1
http://online.wsj.com/article/SB116891615189277255.html
The diet business: Banking on failure
Laura Cummings
BBC News Online, Wednesday, 5 February, 2003, 10:03 GMT
http://news.bbc.co.uk/1/hi/business/2725943.stm
There’s a book titled “Cutting Consciousness Down to Size” that, while not wonderfully written or organized, has some amazing material in it about how unconscious we are all the time. It’s very hard for people to accept or even acknowledge that possibility – but the book has some incontrovertible studies that show it.
Interesting suggestion — the full title is The User Illusion: Cutting Consciousness Down to Size
I would first like to add that reading BR’s article while eating pizza for breakfast had the effect that I started chewing much more slowly.
A la Pavlov I bet the opening bell at a marktet has an effect that is quantifiable on the metabolism of the traders that hear it.
I am reading “The Three Questions that Count” (it is on the list on the right). It provokes thought on this subject.
I msut tkee ecxtpeion wtih one of yuor satetmtens.
—
“Mnay of our bheavoirs and bielef stmesys are baesd uopn elmetnes we are wllhoy uwanrae of.”
Interesting article and relevant to trading and our biases to different market stimuli. As far as the food industry goes, witness how the manufacturers/retailers/restaurants have taken advantage of every single one of the above points, as have their colleagues in the financial industry.
“That which cannot be measured cannot be improved” or the obverse “That which can be measured, can be improved”. I’m not sure where this aphorism came from, but I had a boss that what fond of using it and it is true.
Now and again I have had to go on diets. (Sadly, I’m currently in a “now” phase). I have this terrific program called Cross trainer. It allows you to input everything you eat. (It is also kind enough to allow you to enter the calories you consume through the abundant exercise that I’m sure all of us engage in). You decide in advance what % of your daily diet comes from fat, protein, carbs–so it is flexible.
Now if you are really religious about measuring everything (including the sugar and cream that you put in your coffee) you will soon find (unless you are some ascetic) that you (1) consume more fat than you probably realize; (2) consume more calories (largely due to (1)) than you probably realize. I was mortified to learn one day that through a normal day’s eating about 50% of my calories were from fat–and suet bars were NOT on my list of consumed products.
But I also applied this discipline of measurement to training with my heart rate monitor–and after a year, I could really kick some road and trail running arse! I downloaded my stats and created a daily, weekly, monthly excel schedule and graph to monitor the time I spent in particular zones.
This sort of measurement (no matter what you are measuring–but some body parts need to be left out of this, some things are just not going to get any bigger) is a wonderful way to prove that your mind has no mind of its own, but rather it is really a sinister trickster–the same trickster that tells you that you are more attractive and smarter than most people. I’d be willing to wager that you (and I point that finger at myself as well) engage in all of your good behaviors far fewer times and all of you bad behaviors far greater times than you think.
I’m now motivated to firing up my Crosstrainer program to record the two pieces of bacon that I ate while writing.
These are interesting points. Trying to keep biases in mind is difficult. One of the most dangerous biases is that we sophisticatedly dismantle arguments that we disagree with (Say, bullish arguments) while accepting other (bearish) arguments that suffer from similar flaws. Perhaps this is because we figure if the conclusions are correct (If you already agree with the conclusion) then the thought process that leads to those conclusions is more likely to be right.
A great blog that also covers the subject of human bias is overcomingbias.com. It is a group blog, but Robin Hanson is the reason for the blog.
Give people a taste of Old Crow and tell them it’s Old Crow. Then give them another taste of Old Crow and tell them it’s Jack Daniels. Ask them which they prefer. They’ll think the two drinks are quite different. They are tasting images. – David Ogilvy
Whenever I’m in a bar and someone says they love Ketel / Grey Goose / Belevedere it’s always a kick to challenge them to identify their brand in a blind taste test. Good way to get drunk fast, and have never lost yet LOL
Barry,
Have you ever read anything by Daniel Dennet?
Humans simply cannot communicate their experiences. Much of the time people have no idea what they talk about.
For eg: you and I could both be talking about how “sweet”, sugar is, and be ‘experiencing’ totally different things, and still agree. The whole problem of ‘experience’ and ‘consciousness’ is yet to be understood.
Brain research shows most people make decisions *before* they are consciously aware of them. Heh.
Attached link is a presentation by Whitney Tilson entitled: “Applying Behavioral Finance to Value Investing”.
http://www.tilsonfunds.com/TilsonBehavioralFinance.pdf
Personally, the concept described as “anchoring” is my personal achilles heal. Failing to add to winning trades has cost me dearly over the years.
Oh, and thanks for the link to overcoming bias – cool blog!
#21
In 200 years none of this will matter to any of us anyway. Even if we’re still alive we probably will be wishing we weren’t.
Pretty much all of what we do is a hard wired survival instinct thus sometimes we need to go with the flow.
The most frustrating aspect of my trading is when my itchy trading finger gets into a big argument with my rational and yet not quite profitable systems trades. It may be good for some to have an insignificant amount of money to trade with in order to keep that trading itch in check
Some might enjoy this discussion of mindfulness.
http://youtube.com/watch?v=nqJpADSnjBk
I perceive an irrational urge to clean my plate, despite knowing better that the food will go to waste regardless of whether passing through my body first, which I conveniently blame on family who experienced war-induced food scarcity and brought me up with “no dessert until you finish your meal”. Combine that with oversized lunch meals when you go to restaurants …
Aside from that, eating/snacking is a source of gratification in otherwise dull days that should not be underestimated, and which can be had much more easily than many other gratifications. That’s a quite powerful phenomenon, considering also that much of socializing is tied to meal/snack situations.
Regarding the book “user illusion”, I found it quite long-winded overall and in places repetitive, but would greatly recommend it nonetheless. It’s not an easy read, and you have to bring some serious reading time.
I would point out that generally speaking it’s not primarily the sentiment that kills the rationale behind a healthy investment decision, but just as importantly is what the mind thinks of after making the trade.
As Jesse Livermore put it, “It wasn’t my thinking…”
Thus, the problem that faces most ‘equity buyers’, investors and speculators alike, is being able to rationalize a trade well after the buying or seeling point.
We see instances like this every day of our lives. For example in Jeapordy. Which of your answers is counted the first or the last? Or even waiting for a bus. How many times does the bus come ‘just’ after we leave?
Mark Hulbert had a great article over the weekend, cited in today’s Sentiment/Psychology section of the linkfest explaining how analysts actually would have done much better had they stuck to their initial trades.
Many analysts say “Never buy down”. Well I ask why not? If the fundamental reasons for you buying a stock were there yesterday and they continue to show resilience today with even a better buying opportunity why not buy more for less?
Yes, psychology is important but like in food exercise of the mind and restraint act “mind over matter” is always a good strategy for a slim waist and fat wallet.
Since you are quoting most of the Cornell Psych Dept, you might consider adding Dunning to the list, given his data suggesting that accurate self-assessments of social and other behavior require a certain meta-cognitive abilities lacking in those we’d describe as incompetent. The lesson may apply equally well to the recognition of intellectual errors that lead to poor personal finance and investment decisions.
See the attached for a brief review:
http://eres.olin.wesleyan.edu/eres/docs/12989/dunnwhy.pdf
Actually, there is wine being made in North Dakota. I haven’t had any, though I have had wine made in South Dakota. Some of it was made from grapes from Lodi, which strikes me as cheating, but some of it was locally grown.
Nice article Barry. It is amazing to know about how poor our cognitive abilities can be under a certain set of circumstances, as you have laid out.
Very interesting article.
BTW, all things we believe in are myths… some of them just happen to be true.