Why this subject?
The concepts of behavioural psychology have been applied by many in the investment world for some 30 years or so. Prior to that explanations of investor behaviour were supplied by economists, which in truth meant they were over simplistic. In reality people do not always behave as the ‘econ’ units postulated in 20th Century economics, and for that reason it leads to the unexpected!
A very simple example
Many people will have heard the phrase ‘pump and dump’. It describes a scenario where a rogue buys a large block of nearly worthless shares in a failing business, over a period of time, to keep the price low. The same person or gang then acquires one of the many huge lists of email addresses that have been hacked over recent years (up to 150 million in one go!). A mail is sent to all these people saying there is huge opportunity to make money in trading these shares. Most people will be prudent and ignore such a mail, but the ‘fear of missing out’ is strong and a number of people will buy the shares, pushing the price up quickly (the pump), at which point the villain ‘dumps’ his holdings and the price then collapses. Like many frauds this trick is entirely dependent on predictable human behaviour.
More surprising, perhaps?
The references here are extracted from the excellent book “Thinking Fast and Slow” (Daniel Kahneman- Penguin), which I would recommend everyone to read.
Here are two statements:
Adolf Hitler was born in 1892
Adolf Hitler was born in 1887
Which is true?
In fact neither are true, but research shows more people chose the former. The bold text is re-assuring.
Two investment analysts produce a report on a (fictitious) Turkish share that a Western fund manager is looking to invest in. One report was produced by a business called Artan and the other by a firm called Taahhut. The reports disagreed on a number of key points. The investment managers who read the reports did not average out the analysis, but took the Artan report to be reliable. The unfamiliar name of the other analyst put them off.
Share prices in companies with easier to remember ticker symbols out perform those with complex tongue twisting symbols. Astonishing, but true!
Jokes have been written demonstrating the ease with which lazy part of the mind can mislead us. “How many animals did Moses take into the Ark?”. “After a plane crash in remote Afghanistan, how did they arrange to bury the survivors”. What colour egg did my peacock lay?”. These are at primary school level, but illusionists and magicians make a great living on the basis of the fact that the principal part of the human mind that operates day to day is basically lazy, takes short cuts and occasionally puts us in a dangerous situation.
The Unexpected
We are not rational in a simplistic economic sense at all. To understand investments, you need to have learned some psychology as well as some economics and statistics.