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Friday, 17 October 2014

Facing Down The Narrative Fallacy

Frenzy Time

Markets are tumbling. It's because the Fed is about to push up interest rates. Or maybe because the German economy is weak. Or perhaps it's Ebola, about to decimate global populations. Or it's geopolitical conflict - Ukraine, Syria, Iraq ... take your pick. It's a perfect storm. Head for the hills and don't spare the horses. And remember the shotgun.

Of course, it's none of these. Markets are falling because they were a bit overpriced and investors were ignoring the fact because they'd got themselves into a typical feeding frenzy, ignoring the risk and ambiguity that are always present. Now that they have recognized the issue they're fighting each other to get out the door. Which is why all of the explanations for market weakness are entirely plausible and entirely wrong - they're an example of what Nassim Taleb calls "the narrative fallacy".

Wednesday, 10 September 2014

Be Humble, Become Wealthy

Thrusting, Decisive and Frequently Wrong

We are both by design and by culture inclined to be anything but humble in our approach to investing. We usually invest on the basis that we're certain that we've picked winners, we sell in the certainty that we can re-invest our capital to make more money elsewhere. We are usually wrong, often extremely wrong.

These tendencies come partially from hard wired biases and partly from emotional responses to the situations we perceive ourselves to be in. But they also arise out of cultural requirements to show ourselves to be decisive and thrusting; we rarely reward those who show caution in the face of uncertainty. But we're private investors, we have limited capital and appetite for risk. A little humility - or even a lot - wouldn't go amiss.

Monday, 4 August 2014

Metaphors We Invest By

Lost for Words

Metaphor is a powerful engine for driving thought. Or possibly it's a useful compass for guiding it. Or perhaps it's some other metaphor. The point is the we tend to think in metaphors, even about metaphor, and it seems that the metaphors we use to describe a situation  determine how we view it and what we do about it.

So companies may be in a tail-spin, or simply marking time. Or perhaps they're in terminal decline, or maybe it's merely a temporary setback. And maybe we're talking about the same thing, and how you hear it described determines your reactions to it ... metaphor is powerful, acts on us unconsciously and is almost completely useless to an intelligent investor.

Monday, 28 July 2014

Bad Behavior: From A to Z ... and Back Again

Talking Shop

A common reaction to pointing out to investors (or indeed, anyone) that they're as biased as a Fox reporter at a convention of transgender liberal pacifists is for them to respond, not unreasonably, by asking what they should do about it (that's the investors, not the reporters). It turns out that it's a lot easier to say what's wrong than to actually do anything about it.

The A to Z of Behavioral Bias is an attempt to address that issue, but it does rather show that there's no such thing as a common source of biases; bad behavior comes from many sources and requires many solutions. Or does it?

Friday, 25 July 2014

Z is for Zero Risk Bias

Zero-risk bias is a preference for options that completely eliminate some risk even where alternative, often cheaper, options will reduce the overall risk by more, proportionately.We often prefer the absolute certainty of a smaller benefit to a larger benefit of less certainty.

Thursday, 24 July 2014

Y is for Yawn Effect

The Yawn Effect occurs when you yawn in response to someone else yawning. In fact you can even get your dog to do it (or get coerced into yawning by your pooch). Yawning is contagious, and contagion is an inevitable unconscious consequence of people interacting with each other - and, as usual, when we behave automatically as investors it doesn't make for a good financial outcome.

Wednesday, 23 July 2014

X is for Xenophobia

OK, Xenophobia isn't really a behavioral bias, but Home Bias is its equivalent - the tendency of investors to favor their home markets over foreign ones and to damage their returns, or at least increase their risks, in the process.

Monday, 21 July 2014

Mistrust the Financial Storytellers

Homo narratus

Homo sapiens is the storytelling ape. We make sense of the things that happen in the world, of the things that happen to us, and even of ourselves, through stories and narratives. Consciousness is perhaps best defined as the stories we tell of ourselves as coherent individuals passing through time.

So it's not surprising that we're inclined to favor people who tell stories over those who crunch data. Words are human, numbers - somehow - are not. But the real stories lie in the numbers and, in investment, people who tell stories without the numbers are mystics and shamans, or worse.

Friday, 18 July 2014

W is for Winner's Curse

The Winner's Curse occurs when in order to win a competitive pricing situation such as an auction we overpay. By overpaying we destroy the investment case for buying in the first place and the losers turn out to be the winners. Of course, overpaying for anything is unfortunate, but competition has strange effects on our brains.

Thursday, 17 July 2014

V is for Von Restorff Effect

The Von Restorff Effect states that something that stands out is more likely to be remembered. So a highlighted item on a list is more likely to be recalled than the remainder of the list items. The effect demonstrates the unreliability of memory, which isn't any kind of photographic process but is a more complicated affair, generated on the fly from bits and pieces of information we can bring to mind.