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Wednesday 25 June 2014

I is for Illusion of Control

Illusion of Control refers to our convoluted efforts to retain the belief that we're in control in situations where we really aren't. In fact, having some level of autonomy seems to be important for our psychic health but there are times where we take this to extremes. Like when we think we can predict anything about stockmarkets.


Illusion of control usually involves us confusing situations characterized by luck with those characterized by skill. There's probably no better example of this than the stockmarket, where it often looks like people are demonstrating skill when they actually have no control whatsoever.

One piece of  research showed that the more traders suffered from illusion of control the worse their performance. Another study suggested that this is the key mechanism behind financial panics, because markets tend to go through stable phases in which investors feel they're in control, and unstable ones when it becomes clear that they're not; and the result is a fearful retreat until things stabilize again. Hence people buy high when they feel they're in control, and sell low when they feel they're not.


The desire to feel like we're in control seems to be a very basic human need. Famously the psychologist Ellen Langer was able to demonstrate that giving old people in care homes some very basic control over their environment - giving them a pot plant to look after, for instance - improved their well-being and decreased their mortality. Yes, you read that correctly: giving an old person a plant means they live longer.

There's also some argument that illusion of control is useful in getting people to persist at difficult tasks, but generally it's not a useful trait for investors.


Accepting that you're not really in control of anything in markets is a good start; because once you start believing you can predict the course of short-term events you're already in trouble. If you can't help yourself then write down your three month predictions and then come back to them in three months, and keep repeating until the message gets through. You ain't in control. No one is.

1 comment:

  1. "... because once you start believing you can predict the course of short-term events you're already in trouble."

    But it might be even worse trying to predict long-term events.