hardwired to herdReal pain and social pain are felt in the same parts of the brain.Chandler would make a good investor.Being a successful investor requires not feeling any social pain by doing something thatsvery unpopular...
We can get more wiser or more foolish by following the crowd…When does the wisdom of the crowds becomes madness of the mobs?There are domains where one is better off relying on the crowd
For me, its very useful to quickly zoom into the 10 most emailed articles onNYT.So, when it comes to reading news in NYT, I rely on the “wisdom of thecrowds”In some domains wisdom of crowds works. In some (like ﬁnancial markets)it doesn’t.
“If you want to have a better performance than the crowd, you must do things differently from the crowd.”But when it comes to investing, you are on a VERY different terrain...“People are always asking me where is the outlook good, but that’s the wrong question... “The right question is:Where is the outlook the most miserable? I call this the Principle of Maximum Pessimism... “Let me explain howit works. In almost every activity of normal life people try to go where the outlook is the best... “You look for ajob in an industry with a good future, or build a factory where prospects are best. But my contention is if youare selecting publicly traded investments, you have to do the opposite... “You’re trying to buy a share at thelowest possible price in relation to what that corporation is worth... “And there is only one reason a share goesto a bargain price: Because other people are selling. There is no other reason... “To get a bargain price, you’vegot to look for where the public is most frightened and pessimistic.”Reversion to the mean
“You pay a very high pricein the stock market for a cheery consensus.”
“Most managers have very little incentive to make the intelligent-but-with-some-chance- of-looking-like-an-idiot decision.“Their personal gain/loss ratio is all too obvious: if an unconventional decision works out well, they get a paton the back and, if it works out poorly, they get a pink slip. (Failing conventionally is the route to go; as agroup, lemmings may have a rotten image, but no individual lemming has ever received bad press...“John Maynard Keynes said in his masterful The General Theory: “Worldly wisdom teaches that it is better forreputation to fail conventionally than to succeed unconventionally.” (Or, to put it in less elegant terms,lemmings as a class may be derided but never does an individual lemming get criticized.)”Social Proof + Incentive Caused Bias
“Exchange Alley was in a fever of excitement... The companys stock, which had been at a hundred and thirty the previous day, gradually rose tothree hundred......and continued to rise with the most astonishing rapidity during the whole time that the bill in its several stages was underdiscussion. It seemed at that time as if the whole nation had turned stock-jobbers. Exchange Alley was every day blocked up by crowds, and Cornhillwas impassable for the number of carriages. Every body came to purchase stock.The inordinate thirst of gain that had afflicted all ranks of society was not to be slaked even in the South Sea. Other schemes, of the mostextravagant kind, were started. The share-lists were speedily ﬁlled up, and an enormous traffic carried on in shares, while, of course, every meanswere resorted to to raise them to an artiﬁcial value in the market. Every person interested in the success of the project endeavored to draw a knot oflisteners around him…Exchange Alley was crowded with attentive groups. One rumor alone, asserted with the utmost conﬁdence, had an immediate effect upon the stock.Visions of ingots danced before their eyes. Innumerable joint-stock companies started up everywhere. They soon received the name of Bubbles...Some of these schemes were plausible enough... But they were established merely with the view of raising the shares in the market.But the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one startedby an unknown adventurer, entitled “A company for carrying on an undertaking of great advantage, but nobody to know what it is.”
"I cancalculate the movement ofthe stars, but not the madness of men". - Issac Newton
-92% return in 32 months 1. The speculative public is incorrigible. In ﬁnancial terms it cannotcount beyond 3. It will buy anything, at any price, if there seems to be some"action" in progress. It will fall for any company identiﬁed with "franchising,"computers, electronics, science, technology, or what have you, when theparticular fashion is raging. – BG in The Intelligent Investor.
The speculative public is incorrigible. In financial terms itcannot count beyond 3. It will buy anything, at any price, if there seems to be some "action" in progress. It will fall for anycompany identified with "franchising," computers, electronics, science, technology, or what have you, when the particular fashion is raging. – Ben Graham
“This is a world inhabited not by people who have to be persuaded to believe but by people who want an excuse to believe.”- John Kenneth GalbraithPeople want to latch on to just about any reason to do what they havealready decided to do…But what about money managers? Why do they behave like sheep? Or ratherlike zebras?
Ralph Wanger in “A Zebra in Lion Country”“Zebras have the same problems as institutional portfolio managers. First, both seek proﬁts. For portfoliomanagers, above-average performance; for zebras, fresh grass... “Secondly, both dislike risk. Portfoliomanagers can get ﬁred; zebras can get eaten by lions... “Third, both move in herds. They look alike, think alikeand stick close together... “If you are a zebra, and live in a herd, the key decision you have to make is whereyou stand in relation to the rest of the herd…“When you think that the conditions are safe, the outside of the herd is the best, for there the grass is fresh,while those in the middle see only grass which is half-eaten or trampled down… The aggressive zebras, on theoutside of the herd, eat much better…”
“On the other hand – or other hoof – there comes a time when lionsapproach.”
“The outside zebras end up as lion lunch, and the skinny zebras in themiddle of the pack may eat less well but they are still alive…”
“A portfolio manager for an institution such as a bank’s wealth management department cannot afford to be an Outside Zebra.“For him, the optimal strategy is simple: stay in the centre of the herd at all times... “As long as he continues to buy thepopular stocks he cannot be faulted. To quote one portfolio manager, “It really doesnt matter a lot to me what happensto Johnson & Johnson as long as everyone has it and we all go down together. But on the other hand, he cannot affordto try for large gains on unfamiliar stocks which would leave him open to criticism if the idea fails…”
“Needless to say, this Inside Zebra philosophy doesnt appeal to us as long-term investors.. We have tried to be Outside Zebras most of the time, andthere are plenty of claw marks on us."Ralph Wanger in “A Zebra in Lion Country”
We are willingto look foolish as long as we dont feel we have acted foolishly.
A committee is agroup of people who keep minutes and waste hours - Mark Mobius, Templeton Funds
Why does this happen?What models explain this?Why do independent directors no speak against stupid resolutions?
The Bystander Effecthttp://www.youtube.com/watch?v=OSsPfbup0ac
Kitty GenoveseMurder of Kitty Genovese - Wikipedia, the free encyclopediahttp://en.wikipedia.org/wiki/Murder_of_Kitty_GenoveseWe don’t just copy the actions of others, we also copy their inactions...
The effective saints of civilization…They don’t fall under biases from overinﬂuence of authority or socialproof...
“If fifty million people say afoolish thing, it is still a foolish thing.” - Anatole France
frontline: dot con | PBShttp://www.pbs.org/wgbh/pages/frontline/shows/dotcon/The scene shows how Americans went crazy over dotcoms. It also showshow ecstatic employees of E-Loan felt when their stock options in thecompany which had just gone public became so valuable that some of thembecame millionaires.
These are E-Loan employees. The company just listed. It has NO business. It’s office is EMPTY.The market value of the company is $2 billion.Notice they just had an unexpected pleasant surprise.We are VERY INTERESTED in studying such people. What happens to them? What is their “state ofmind?”They are so happy, and so foolish (we know this of course with the beneﬁt of hindsight as almostall dotcoms fell by more than 90% post listing).People were equally ecstatic during Tulipomania, The South Sea Bubble.
People are Most Credulous when they are most happyWalter Bagehot was right. When people are happy, they will believe almostanything. They become extremely suggestible.We want to know what’s happening inside the brains of very happy peoplewho just made an unexpected killing in the stock market, or won a lottery,or won in the casino...
“This is a world inhabited not by people who have to be persuaded to believe but by people who want an excuse to believe.”- John Kenneth GalbraithPeople want to latch on to just about any reason to do what they havealready decided to do…Galbraith was right.You should read two of his books - The Great Crash 1929, and A ShortHistory of Financial Euphoria.“Financial Euphoria”. Nice term. Is it similar to other kinds of euphorias?What other domains exist in which humans experience euphoria?
There is no difference between a man who just made a killing in the markets and a man who is high on cocaineDoctors cannot tell the difference from fMRI scans between the two.So we now know that doing drugs and making a killing in the markets are virtuallyidentical.
If lab rats are wired up to receive tiny pulses of electrical stimulation in the dopamine centers of the brainwhen they press a lever, they often begin tapping it nonstop to the exclusion of other activities, includingeating and drinkingThey would rather starve to death than live without that dopamine surge inside their brains.The human equivalent of this Lab Rat is there in all of us…After all, don’t we keep on clicking on link after link on the internet, using the mice of our comps just to get anovelty-induced kick? Internet addiction is like all other addictions…What are the consequences of internet addiction?
“The thrill of the chase blinded the pursuers to the consequences of the catch.” - Buffett
Addicted gamblers chain themselves to slot machines“Chains of habit are too light to be felt, until they are too heavy to bebroken” - Buffett
Studying the business of gambling and gambling addiction is a great way to learnabout human nature.What I really love is how it gets rationalized…If you work for a gambling casino as an employee, how would you respond to theidea that gambling is bad for civilization?Are their functional equivalents of gambling casinos? How about day-trading? Orspeculating in derivatives?
Nothing sedates rationality like large doses of effortless moneyI love this quote. He knows what it must be like to make a lot of money.
What happens to a gambler who through sheer randomness wins the jackpot? What is he going to think? Was it luck? Of course not.He is going to think “his system works.” And then he is going to think “this is just the beginning, and I am on a roll, I can see thefuture, nothing can stop me - I am the master of the universe.”For him, this one time-lucky gain would look like the initial cash ﬂow from a growing perpetuity he just created with his “effort.” Hewill start having “delusions of grandeur,” he will start thinking, “why do I have to even go to my clinic to see my patients and earnonly so much, I can do much better by just using my system to get rich.”What’s going on in the head of this man? Well, his head is practically drowning in a rush of dopamine…General principle: When your dopamine levels are high, you risk becoming over-conﬁdent and foolish.This is a man in a “HOT STATE”. So were the people who worked for E-Loan at the time they learnt they were paper millionaires. Sowere the people who thought they had become rich permanently because they owned a very rare and very precious tulip bulb.Are there any other “HOT STATES?” Yes there are...
Unexpected pleasant surprises make people ecstatic because of the dopamine surge they produceGetting what you expected produces no dopamine kickHowever, an unexpected gain ﬁres up the brain (neurons go from ﬁring 3 times a second to 40times a second)If expected reward fails to materialize, dopamine dries upIf you want to make your girl/boy friend really happy, give her/him an expected pleasant surprise-but don’t make a habit of it for then it will cease to be a surprise.
Dopamine system loves novel stimuli. Variety is the spice dope of [market] lifeVivid stock market screens and real time charts offer frequent change (i.e. volatility) and sometimes unexpected goodsurprises, thereby producing surges of dopamine which results in addiction.Day traders, like cocaine addicts, are in it more for the dopamine than for the money.Internet addiction - our lowing attention spans, caused due to distractions...We love observing fast action because its EXCITING!
“Severe change and exceptional returns usually dont mix.“Most investors, of course, behave as if just the opposite were true. That is,they usually confer the highest price-earnings ratios on exotic-soundingbusinesses that hold out the promise of feverish change…”
“That prospect lets investors fantasize [THINK DOPAMINE] about future proﬁtability rather than face todaysbusiness realities. For such investor-dreamers, any blind date is preferable to one with the girl next door, nomatter how desirable she may be.”IPOs, New Hot Stocks e.g. dotcoms, Fashion industry, Movie business, Music business, Airline industryAverage person buys more aggressively in response to recent price rises - expectation of further rises
“We make bricks in Texas which use the same process as in Mesopotamia.” - MungerWarren Buffett has made most of his money in businesses which you mayconsider as BORING - Carpets, furniture, insurance, candy, cola…People who invest in “exciting” businesses - are they doing it for the moneyor the dope?
The Milgram experiment is the most cited experiment in social psychology.http://www.youtube.com/watch?v=BcvSNg0HZwkhttp://www.youtube.com/watch?v=IzTuz0mNlwUhttp://www.youtube.com/watch?v=CmFCoo-cU3YPsychology textbooks include this experiment in the chapter that deals with conformity or authority.However, something as big as this (a lollapalooza outcome) simply cannot be explained by ONE model.There are other models in force here. Can you identify them?
http://www.youtube.com/watch?v=y6GxIuljT3wThe Milgram experiment has been replicated several times. And every timethe results are the same. The majority of the participants go all the way...
“More Hideous crimes have been committed in the name of obedience than in the name of rebellion.” - C.P. SNOWThroughout history, the plea “I was only following orders” has been offeredto excuse actions carried out on behalf of orders that were foolish,destructive, or illegal.
The Jonestown Massacre is another much-studied incident in socialpsychology textbooks.http://www.youtube.com/watch?v=D7IxGGfpSWkhttp://www.youtube.com/watch?v=u9rSN05Pi94http://www.youtube.com/watch?v=_myD9eXv20UAgain, something as big as this, cannot be explained by one model alone.
As I write, highly civilized human beings are ﬂying overhead, trying to kill me. They do not feel any enmityagainst me as an individual, nor I against them. They are ‘only doing their duty’, as the saying goes. Most ofthem, I have no doubt, are kind-hearted law-abiding men who would never dream of committing murder inprivate life. - George Orwell.
We are conditioned to blindly accept authority. After all mom is always rightisn’t it?
The Hospital ExperimentFrom Cialdini’s Inﬂuence:Group of researchers, composed of doctors and nurses with connections to three hospitals.To twenty-two separate nurses’ stations on various surgical, medical, pediatric, and psychiatric wards, one of the researchers madean identical phone call in which he identiﬁed himself as a hospital physician and directed the answering nurse to give twentymilligrams of a drug (Astrogen) to a speciﬁc ward patient.(1) The prescription was transmitted by phone, in direct violation of hospital policy. (2) The medication itself was unauthorized;Astrogen had not been cleared for use nor placed on the ward stock list. (3) The prescribed dosage was obviously and dangerouslyexcessive. The medication containers clearly stated that the “maximum daily dose” was only ten milligrams, half of what had beenordered. (4) The directive was given by a man the nurse had never met, seen, or even talked with before on the phone.
Yet, in 95 percent of the instances, the nurses went straightaway to theward medicine cabinet, where they secured the ordered dosage of Astrogenand started for the patient’s room to administer it. It was at this point thatthey were stopped by a secret observer, who revealed the nature of theexperiment...
Flight Simulator Experiment cited by Charlie Munger:“You get a pilot and a co-pilot. The pilot is the authority ﬁgure. They don’tdo this in airplanes, but they’ve done it in simulators. They have the pilotdo something where the co-pilot, whos been trained in simulators a longtime - he knows he’s not to allow the plane to crash - they have the pilot todo something where an idiot co-pilot would know the plane was going tocrash, but the pilot’s doing it, and the co-pilot is sitting there, and the pilotis the authority ﬁgure. 25% of the time the plane crashes…”
Mr. Buffett has correctly called stock market as a “semi-psychotic creature given to extremes of elation and despair.”However, the vast majority of people, and academic ﬁnance in particular, treat market prices as correct and give it the respect reserved forauthority ﬁgures….Buffett writes the following about Ben Graham’s “Mr. Market” metaphor in his book, “The Intelligent Investor”:“Ben Graham explained why in Chapter 8 of The Intelligent Investor. There he introduced “Mr. Market,” an obliging fellow who shows up everyday to either buy from you or sell to you, whichever you wish. The more manic-depressive this chap is, the greater the opportunities available tothe investor. Thats true because a wildly ﬂuctuating market means that irrationally low prices will periodically be attached to solid businesses. Itis impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to eitherignore the market or exploit its folly.”By giving too much importance to Mr. Market, most investors make a fundamental mistake of converting their basic strength into a weakness
The Pied Pier of Hamlyn was a very charming authority ﬁgure and when hecast his spell, everyone followed. The consequences for following for thisblind obedience were not good.There have been many pied pipers in ﬁnancial history….
Mr. Harshad Mehta and Mr. Ketan Parikh were two pied pipers India hasseen.No doubt there will be others…
The consequences for people who followed these pied pipers weredisastrous.Remember that it wasn’t just the “gullible” individuals who drowned. Therewere many institutional “investors” who had the same fate. Indeed, at onepoint there were funds created with a declared plan to invest “only in the K10(the top ten favorites of Mr. Ketan Parikh) stocks.”The funds took in a lot of money. And then drowned...
When evaluating management beware of the authority. You may think they know better, but veryoften they don’t.They are just too close to the situation. They often miss the BIG PICTURE, which a matureseasoned security analyst can have.See “Biased Assimilation and Attitude Polarization.” - People too close to a situation experiencenoise which mis-inﬂuences them.Keep you skeptical hat on when you meet management. And don’t forget to carry a few pinches ofsalt...
“Science alone of all the subjects contains within itself the lesson of the danger of belief in theinfallibility of the greatest teachers in the preceding generation... Learn from science that you mustdoubt the experts. As a matter of fact, I can also deﬁne science another way: Science is the belief in theignorance of experts.”- Feynman
“In some disciplines, “expert” is the closest thing to a fraud performing no better than acomputer using a simple algorithm.” - TalebBe wary of “experts”
“There are 60,000 economists in the U.S., many of them employed full-time trying to forecast recessions andinterest rates, and if they could do it successfully twice in a row, theyd all be millionaires by now...as far as Iknow, most of them are still gainfully employed, which ought to tell us something.” - Peter Lynch, One Up OnWall Street
We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements issomething we think neither we noranyone else can do.
Like a Don Juan or a Casanova, the chartist has an unending series of shortaffairs with stocks. First there is observation, a watching of the head andshoulders, the neckline, and the shape of the bottom. Flirtation may involvesome resistance or some support. As involvement increases, congestionbuilds. There may be penetration of old tops, or a violation of former lows.These give way to mounting excitement and then climax, followed by thewarm afterglow of proﬁt taking. – Burton Malkiel
Burton Malkiel "The markets rise after a period of reaccumulation is a bullish sign. Nevertheless, fulcrum characteristics are not yet clearly present and a resistance area exists 40 points higher in the Dow, so it is clearly premature to say the next leg of the bull market is up.“If, in the coming weeks, a test of the lows holds and the market breaks out of its ﬂag, afurther rise would be indicated. Should the lows be violated, a continuation of theintermediate term downturn is called for. In view of the current situation, it is a distinctpossibility that traders will sit in the wings awaiting a clearer delineation of the trend and themarket will move in a narrow trading range." If you ask me exactly what it means, Im afraid Icannot tell you, but I think the technician probably had the following thing in mind: "If themarket does not go up or down, it will remain unchanged."– Burton Malkiel
We believe that short- term forecasts of stock or bond prices are useless. The forecasts maytell you a great dealabout the forecaster;they tell you nothing about the future.)
short-term market forecasts are poison and should be kept locked upin a safe place, away from children and also from grown-ups who behave inthe market like children.
We have two classes of forecasters: Those who dont know –and those who dont know they dont know – Galbraith.
We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks,the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury billyields ﬂuctuating between 2.8% and 17.4%.But, surprise - none of these blockbuster events made the slightest dent in Ben Grahams investment principles. Nor did theyrender unsound the negotiated purchases of ﬁne businesses at sensible prices. Imagine the cost to us, then, if we had let a fearof unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases whenapprehensions about some macro event were at a peak. Fear is thefoe of the faddist, but the friend of the fundamentalist.Social Proof + Authority (predictions by experts),
Tetlock is the fella who demonstrated the lunacy of the idea of most “experts” in social science...People who make prediction their business— people who appear as experts on television, get quoted innewspaper articles, advise governments and businesses, and participate in punditry roundtables—are nobetter than the rest of us. When they’re wrong, they’re rarely held accountable, and they rarely admit it,either. They insist that they were just off on timing, or blindsided by an improbable event, or almost right, orwrong for the right reasons.Required Reading:http://www.newyorker.com/archive/2005/12/05/051205crbo_books1
“The fox knows many things, but the hedgehog knows one big thing.” - Isaiah BerlinTetlock borrows a marvelous metaphor from Isaiah Berlin.A Hedgehog knows how to curl itself into a ball to escape its enemies.That’s all he knows. A fox on the other hand has many more models in hishead...
Berlin divides writers and thinkers into two categories: hedgehogs, whoview the world through the lens of a single deﬁning idea...
...and foxes who draw on a wide variety of experiences and for whom theworld cannot be boiled down to a single idea.
Follow Single Doctrine Avoid Ideology One Big Idea Lots of Ideas (multi-disciplinary) Flexible Mind (Know how to Cling on to their One Big Idea deal with surprise) Conﬁrmation Bias No Conﬁrmation Bias Overconﬁdent Doubtful Articulate Not very Articulate Poor predictive ability, but Better Predictors occasionally bang on targethttp://en.wikipedia.org/wiki/The_Hedgehog_and_the_Foxhttp://www.longnow.org/seminars/02007/jan/26/why-foxes-are-better-forecasters-than-hedgehogs/
http://www.youtube.com/watch?v=gUkbdjetlY8Here is an example of a hedgehog…
When they’re wrong, they’re rarely held accountable, and they rarely admit it, either. They insistthat they were just off on timing, or blindsided by an improbable event, or almost right, or wrongfor the right reasons.http://www.youtube.com/watch?v=ayGcF8dnTV0
http://www.youtube.com/watch?v=IaO69CF5mbYFeynman, clearly was a fox - full of doubt, and never certain about almostanything...
Fox or Hedgehog? How to Spot them?Tetlock:“Count how often they press the brakes on trains of thought. Foxes often qualify their arguments with"however" and "perhaps," while hedgehogs build up momentum with "moreover" and "all the more so."Foxes are not as entertaining as hedgehogs. But enduring a little tedium is worth it if you want realisticodds on possible futures.”“Listen to yourself talk to yourself. If youre being swept away with enthusiasm for some particularcourse of action, take a deep breath and ask: Can I see anything wrong with this? And if you cant, startworrying; you are about to go over a cliff.”