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Sunday, 29 March 2009

Bulletin Boards are Bad for Your Wealth

Buyer Beware of the Boards

Lots of us, including me, frequent investment related bulletin boards discussing shares and such stuff. They’re full of like-minded people, offering opinions on various investments. If it’s what you’re into they're fun, informative and can generate lots of useful ideas.

They can also be extremely damaging to your investment returns. Bulletin boards are exactly the wrong way to discover investment information unless you know precisely what you’re doing.

Tricking Your Addicts

Weightwatchers and Alcoholics Anonymous use a psychological trick called committment bias to encourage members not to backtrack – once you make a public commitment to a position it’s very hard to retract it. So when people take a public position on a stock or a market on a board they’ll tend to stick with it, regardless of disconfirming evidence that suggests they shouldn’t. Worse, in fact, they'll be increasingly inclined to ignore disconfirming evidence. We saw the same effect with supposed experts, so seeing it elsewhere shouldn't be a surprise.

Once a theme or interest in a stock gets going it’ll tend to attract a bunch of like minded people with the same interest. This is doubly dangerous. Firstly people will act to reinforce each other's views, and will combine to attack those offering a dissenting opinion. Secondly standard social proof effects will start to take hold. These, essentially, are the triggers that we use in everyday life to confirm that we’re behaving in line with the social norms.

Not sure whether to eat the bread roll on the left or on the right? Look at what others are doing. When we’re uncertain we look to other people for cues on how to behave and this works beautifully most of the time in the real world. On bulletin boards and in other social networking environments dedicated to stockmarket investment it can be horribly damaging.

Boiling Your Frogs

Unfortunately changes in a business environment don’t normally happen quickly and certainly the public awareness of them is usually slow to catch up. It’s the difference between popping a frog in a pan of boiling water and putting it in cold water and heating it up slowly. Those slow, insensible changes aren’t easily spotted and if you’re in a group of like-minded individuals, reinforcing each other’s opinions, you’ll never detect them until it’s too late. We saw a lot of this in the wake of the dotcom crash and more recently about banking stocks as they collapsed under the weight of debt. Still everyone else was still holding, so it must be OK, yes?

Well, no, actually.

Electrifying Your Gurus

Additionally people who have demonstrated success on boards will acquire gravatis and authority and others will start looking to them for evidence of how to behave. When “behaviour” equates to buying, selling or holding stocks this ends up simply being a way of delegating decision making. The trouble is that you don’t know whether the authority figure has been right in the past because they’re smart or lucky – or whether they’ll be stupid or unlucky in the future. Once you start seeing messages appearing asking certain “gurus” for advice you know that someone's having trouble thinking straight. Just make sure it isn't you.

For evidence of our tendency to delegate to authority there’s a famous and terrible experiment by a psychologist called Stanley Miligram from Yale University in which he asked subjects to electrocute people. The people were actually actors pretending to be electrocuted, but the subjects didn’t know that and most of them kept on turning up the juice when instructed to do so even when their “victims” were begging them to stop. We're wired to delegate difficult decisions to authority but sadly in investing the only losses you make are your own.

Envying Your Neighbours

Furthermore one the biggest problems with investing is simple envy. Nothing makes you feel poorer than seeing your neighbour become rich and bulletin boards make sure we can see lots of neighbours. Once a boom starts and people start getting rich this visibility will tend to attract lots of fellow followers. The original investors may have been highly skilled or may have been lucky, but it makes no difference to later arrivals: they just want some of the same. Once again social confirming effects then start to take hold and once again people stop thinking for themselves.

These types of follower effects are often built on a simple fallacy of judgement that the human mind is oft inclined to engage in. Basically it extrapolates from the past to the future, assuming that behaviour we’ve seen in the recent past will continue into the future forever. Lots and lots of sales pitches are based on this – showing short term gains and then leaving it to the imagination of the purchaser to envisage these going on forever. That new car effect only lasts until you drive it off the forecourt. The idea that by buying the latest exciting and rapidly rising stock you will see it carry on going up forever is just plain ludicrous, as is the idea that you can flip it before everyone else, but that’s what many people seem to assume when carried away on waves of envy.

Combining Your Inner Demons

On their own these different factors are nasty and can lead to unfortunate side effects – mainly losing all your money. Together they can cause all sorts of ridiculous behaviour from the hero worship of phantom gurus and the chasing up of stock prices regardless of the fundamentals through to the complete abdication of normal thought processes and the removal of even basic requirements for evidence and proof.

The simplest way to deal with this is to ignore the boards and other social media when it comes to investment. In fact ignoring pretty well all opinion based commentary on stocks and markets is more or less the best bet. However, for active investors there is lots of useful information on stock related bulletin boards, in amongst the dross, so sometimes arming yourself to do battle in these places is worthwhile.

Most important is to understand these underlying biases and mental ticks. They’re built-in to the way we work, mainly for good reasons, in everyday life. When it comes to money and markets, though, they can be counterproductive and we need to be constantly on our guard.

Disconfirming Your Inititions

Possibly the most important thing is to look for disconfirming evidence. The classic example of this is to set people a test to tell you what the rule is behind a sequence of numbers. They can ask any question they want and as many as they want before giving an answer.

The sequence is 2, 4, 6. Most people will think and then ask if 8, 10 12 :) meets the rule. They’re told it does. So then they ask if 14, 16, 18 meets the rule and again it does. Sometime around this point they announce that the rule is even numbers increasing by 2.

However, they’re wrong – the rule is any three numbers in increasing order – 1, 2, 3 or 10, 100, 1000 or any damn rising sequence you want. The problem is that people are only asking questions to confirm their theories, not to disconfirm them. It’s the disconfirming evidence we must always look for because otherwise we’re always going to be patsies.

If you engage in public traffic on bulletin boards you have to accept that from time to time you'll get suckered in. If the value you get out of participating is worth it then that may be a price worth paying. Just make sure you have your disconfirming machine in place to check your conclusions, otherwise you'll likely find yourself poorer and no wiser.




Related articles: Robert Cialdini and the Weapons of Influence, Disposed to Lose Money, The Psychology of Scams

2 comments:

  1. Be careful, you may discover writing a blog isn't that great for your wealth either. ;) (Not just because you can feel extra-wedded to positions, but because writing posts takes hours!)

    http://monevator.com/2008/11/18/blogging-for-money/

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