The Wall Street Journal recently ran the article by Jason Zweig titled, “This Is Your Brain on a Hot Streak”. Zweig notes a nationwide investor survey that shows we are hardwired to miss the market.
Administered by Decision Research—a nonprofit think tank—the survey showed how investors predicted the market would continue to move higher … after the market already rose. And after the market had already fallen … investors predicted the market would continue to go down.
In essence, the forecast of market returns over the coming year was heavily influenced by how the market performed during the prior month. And the author makes an interesting point: investors may not have had choice. He writes …
“The investing mind comes with built-in machinery that sizes up the future based on a surprisingly short sample of the past. Neuroscientists say the human brain probably evolved this response in a simple environment in which the cues to basic payoffs like food and shelter changed slowly and rarely, making the latest signals most valuable—nothing like what today’s investors face with electronic markets in a constant state of flux.”
The premise behind this research reaffirms the observations I put forth in my upcoming eBook “Systematic Wealth”. I tackle many of the major issues that block investors from maximizing portfolio returns—all in plain English.
And being “hard wired” to miss market trends isn’t the only issue. This is compounded with other issues to create a perfect storm for losing money unnecessarily.
Take for instance the crowd behavior of Wall Street. Individual investors tend to depend on others in the crowd for their information. And since most people get all of their financial information from the same sources … CNBC, newspapers, tipsters, and analysts … the investor’s mind unconsciously says there is not enough “other” information to make a judgment.
Therefore, I must rely on the “herd”.
Predicting the Present and Missing the Future
And the biggest error with crowd behavior is “linear extrapolation”. Or predicting the future by simply extrapolating the present into the future. And in a fast changing world … and a fast changing market … this approach is doomed to fail. Because of this, investors and their advisors have been notoriously optimistic at market tops and pessimistic at market bottoms—with devastating results.
And the stronger the mood of the crowd … so too is the strength of the crowd’s conviction. How else could one come to understand that why at the top of the Dot.com bubble, companies with no revenue let alone earnings, were being priced into the stratosphere.
So what’s the average investor supposed to do? We are hardwired for missing market trends and crowd behavior isn’t serving us either.
“The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell”
It is absolutely critical for investors to gain a contrary position to the heard. Read the statement from John Templeton again. When the news is very negative, it is usually AFTER the market has gotten whacked. Think March/April 2009 there was massive pessimism at a significant bottom.
Logically we would want the media to be alerting us to danger at the TOP….not at the bottom. But reporters report. They report what has already occurred—that’s what they’re paid to do.
This is why “Systematic Wealth” is such a powerful tool for any investor. By removing human emotion and the faulty hardwiring from the equation … market data and rules based investing can lead you through any market cycle … and into profitability.
To learn more, be sure to get your FREE copy of my eBook—Systematic Wealth.