Beware of These Trader's Mind Traps
Thursday, October 1, 2009 | Bob De DeaRating:
"There is nothing either good or bad, but thinking makes it so." -- Hamlet
"It is difficult to get a man to understand something when his salary depends upon his not understanding it." -- Upton Sinclair
"The idea that private industry can always do something better than the government is false and sad and divisive." -- Robert W. Taylor, the ARPA employee who first envisioned the internet
Shakespeare Hits the Nail on the Noggin
Don't worry. I'm not making a case for ethical relativity with the Hamlet quote above. I'm merely stating the fact that we are often prisoners of our own perspectives.
Sure, we are human and will only ever see things from one perspective because everything -- and I do mean everything -- filters through the individual's brain. But this is no reason not to try to understand the process of belief and how our beliefs affect our decisions.
This is what I've been trying to do in this article series, based on the book "Predictably Irrational: The Hidden Forces That Shape Our Decisions" by Dan Ariely.
I've been trying to sort out the things that we take for granted, to bring to light our personal predilections, to give us clues as to how others think about things, in order to make us more aware and better investors.
Here's an experiment from the early '90s by Dr. J.B. Moseley on the way our thoughts influence reality.
- Situation as Diagnosed: Arthritic condition of the knee
- Typical Solution: Arthroscopic surgery
- Desired Effectiveness: Pain relief and improved ability to walk
There were three test groups.
Group 1 got the whole kit-and-kaboodle: anesthetic, three incisions on the knee, scopes inserted, cartilage removed, correction of soft-tissue problems and 10 liters of saline wash. This was what's known as the Control Group.
Group 2 got the anesthetic, three incisions, scopes inserted and 10 liters of saline wash.
Group 3 go the anesthetic and three incisions but nothing was inserted into the knee -- this was simulated surgery.
Can you guess where I'm going with this?
The medical researchers followed the recipients of these procedures for two years, tested them for reduction in pain and the length of their recovery before they were able to walk and climb stairs.
Those who received the full arthroscopic treatment were delighted with the results and would recommend the procedure without hesitation. Funny thing was that the placebo group -- those who received no real treatment -- experienced pain relief and improvement in mobility (and here's the kicker) to the exact same extent as the control group.
This may not be news to many of you. It's why some treatment (even quackery) will almost always work for some people. Faith in a product, or confidence in a caregiver, can be enough to make us feel better (or to make our internal process of healing kick in).
And, if this is so, we can continually find that we are prone to believe in certain things, whether or not they are effective in and of themselves, or whether objective reality (what some may call "truth") is being disregarded.
We can look at Pavlov's dogs and laugh, but we are far from being immune to conditioning.
Holy Hands, Popeman!
For centuries, the popes consecrated the Holy Roman Emperors (hence the modifier "holy"). From the first anointing on, kings were considered divne.
Masses thronged to them for the "royal touch" -- their healing hand. Thousands of people, subjects and foreigners alike (including American colonists) would travel to the Emperor or King just to be touched.
And thousands were healed.
That is, until the 1820s when monarchs "lost" their divinity and were seen to be "merely" human.
Of course, all kinds of snake-oil remedies were coming on the scene by that time. And they worked, too -- not because of their medical efficacy but because people wanted them to. The only miracle behind them was the power of suggestion to improve the health of the wonderfully remarkable self-healing human body.
How this relates to us in the present day:
Do you only trust the more expensive brand-name medicines available to you, or will you opt for the less-expensive generic? The power of branding is something else. But knowing that it's the brand and not the product that is making you think -- for instance, that generics are less effective because they're cheaper -- can cause you to snap out of it and consider the facts.
This is all true for advertising, for political spinning, for the next greatest stock opportunity -- you name it, we're suckers for words.
Ever-hopeful suckers.
That's why we cannot repeat enough just how much an unemotional approach to your finances is paramount to your achieving your financial goals.
Believe me; I learned it the hard way.
Dishonesty -- It's Such a Lonely Word
Now to shed some light on why people think they can get away with stuff. ...
Come on, admit it. We all do try occasionally to pull one over on somebody or some organization.
Everything from pencils or copy paper from work ... to another glass of soda from the drink dispenser ... to inflated insurance claims ... to misrepresenting tax write-offs ... to returning clothes worn once ... to backdating stock options -- if someone hasn't done it, they might have thought about it.
How else could loss from employee theft or fraud be close to $600 billion every year?
As a comparison, all robberies in the U.S. in 2004 amounted to around $525 million, with an average loss of $1,300. That's twice the market capitalization of General Electric.
The honest truth is that honest people (or people who generally think of themselves as honest) occasionally cheat. "Individuals are honest only to the extent that suits them," Ariely writes.
He's not being pessimistic; he's being descriptive as a result of long hours of observation and experimentation. One of the interesting things he discovered is that thinking about morality or requiring people to take an oath right before the moment of temptation almost eliminates the likelihood that they will cheat.
Remember in an earlier segment when we talked about market norms and social norms?
Getting people to stop thinking about monetary recompense and start thinking about how what they're doing affects society as a whole is the key to effecting change that benefits more than just one's self.
Thinking in terms of our selfish interest permits us to bend reality like water bends light, steeling us toward dishonest behavior.
Adding it All Up
In several controlled studies, adults were given a test of 20 simple math problems (finding two fractional numbers that added up to 10 from among a group of numbers).
Some had to submit their answer sheet, which was graded. A monetary reward was given for each correct answer. (Again, this was the control group.)
Some tore up their answer sheet and simply told the collector how many they got right. They got paid accordingly.
The last group also shredded their answer sheet and gave the collector a figure. They did not receive money, however, but instead a token for each right answer that they could redeem for cash on the other side of the room, 12 feet away.
The average for the first group was 3.5 right answers with a cash reward of 50 cents per correct answer. The second group (who tore up their worksheets) solved an average of 6.2 questions with the same cash reward. So this group cheated by inflating their score an average of 2.7 questions. (But out of 2,000 participants in similar studies of honesty, only four people claimed to have solved all the problems correctly.)
The third group -- no smarter than the previous two, mind you -- claimed to have figured out the correct answers to 9.4 problems, 5.9 more than the control group (and 3.2 more than group two). But of the 450 subjects who participated in this "tokens" study, 24 of them declared to have solved all 20 problems.
Do the math.
The Impact of Instant Gratification
Apparently non-monetary currency increases the likelihood of dishonesty. And this was an immediate-reward situation -- the tokens were exchanged in a matter of seconds.
As Ariely points out, "What would the rate of dishonesty have been if the transfer from a non-monetary token to cash took a few days, weeks, or months (as, for instance, in a stock option)?"
Further, he writes,
"When we look at the world around us, much of the dishonesty we see involves cheating that is one step removed from cash. Companies cheat with their accounting practices; executives cheat by using backdated stock options; lobbyists cheat by underwriting parties for politicians; drug companies cheat by sending doctors and their wives off on posh vacations.... [C]heating is a lot easier when it's a step removed from money.
"Do you think that the architects of Enron's collapse ... would have stolen money from the purses of old women? Certainly, they took millions of dollars in pension monies from a lot of old women. But do you think they would have hit a woman with a blackjack and pulled the cash from her fingers? You may disagree, but my inclination is to say no."
"Do you think that the architects of Enron's collapse ... would have stolen money from the purses of old women? Certainly, they took millions of dollars in pension monies from a lot of old women. But do you think they would have hit a woman with a blackjack and pulled the cash from her fingers? You may disagree, but my inclination is to say no."
Why is this important? Why must we realize that, once cash is a step removed, we will have a tendency to cheat in a bigger fashion than we could imagine?
Because cash, as we can observe for ourselves, is readily disappearing in real-world transactions. It's absence could be why more corporate corruption comes to light every day.
An accountant only works with numbers that may represent literal money but they certainly don't have the same psychological weight as if he or she were counting bills and sorting them and appropriating them to different tasks or departments or investments.
The Bottom Line isn't the Bottom Line
As I said when we started, traditional economic theory holds that we are rational -- that we know everything we need to know to make a decision -- including the value of other options, and that we have no hindrance in considering the consequences of each potential choice before us.
To turn again to Ariely in summary:
"The result is that we are presumed to be making logical and sensible decisions. And even if we make a wrong decision from time to time, the standard economics perspective suggests that we will quickly learn from our mistakes either on our own or with the help of "market forces." On the basis of these assumptions, economists draw far-reaching conclusions about everything from shopping trends to law to public policy.
"But ... we are all far less rational in our decision-making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless -- they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. ... Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?"
"But ... we are all far less rational in our decision-making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless -- they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. ... Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?"
We tend to take credit for our successes and to blame circumstances or others for our failures. Our estimation of our own accomplishments are often overblown and we fail to give credit where credit's due -- to chance, to class, to being in the right place at the right time, to our subordinates, to the timing, and a myriad of other things we fail to consider as wielding influence.
On the other hand, when we don't succeed, it's often these same things that we will propose as the obstacles that stood between us and our success.
In other words, we have no real perspective from which to judge properly.
"[W]e are pawns in a game whose forces we largely fail to understand. We usually think of ourselves as sitting in the driver's seat, with ultimate control over the decisions we make and the direction our life takes; but, alas, this perception has more to do with our desires -- with how we want to view ourselves -- than with reality.
"[There are] forces (emotions, relativity, social norms, etc.) that influence our behavior. And while these influences exert a lot of power over our behavior, our natural tendency is to vastly underestimate or completely ignore this power. These influences have an effect on us not because we lack knowledge, lack practice, or are weak-minded. On the contrary, they repeatedly affect experts as well as novices in systematic and predictable ways."
"[There are] forces (emotions, relativity, social norms, etc.) that influence our behavior. And while these influences exert a lot of power over our behavior, our natural tendency is to vastly underestimate or completely ignore this power. These influences have an effect on us not because we lack knowledge, lack practice, or are weak-minded. On the contrary, they repeatedly affect experts as well as novices in systematic and predictable ways."
Remember that optical illusion I used a few articles ago? The master of all perception is our mind, or, if you prefer, our brain.
"By the time we comprehend and digest information, it is not necessarily a true reflection of reality. Instead, it is our representation of reality, and this is the input we base our decisions on. ... Once we understand when and where we may make erroneous decisions, we can try to be more vigilant, force ourselves to think differently about these decisions, or use technology to overcome our inherent shortcomings."
Part of what the experts here at Tycoon offer is the ability to learn to free ourselves from these limitations. That's why Teeka worked so hard and for so long on Sector Hunter -- a black-box system that does what it can to eliminate human emotion from the equation; or Swing Point Trader, where purely technical trade opportunities are generated automatically.
That's why Chris spent years developing his Internal Strength System -- to train us to look at the market differently, through new eyes unencumbered with presuppositions about what the market might do.
Whether it's thinking about which sectors or options to invest in, or thinking about cap-and-trade or the public option in healthcare, or even thinking about whether you should expense a meal with a friend as a "business lunch" -- start now to pause, think of the person you imagine yourself to be and, in your moment of decision, choose to be that person.
Take back your mind. You'll be one step along on the road to making the world a better place.
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Bob De Dea
Guest Contributor
The Tycoon Report
