Investing Behaviour

“Just as nature abhors a vacuum, people hate randomness. The human compulsion to make predictions about the unpredictable originates in the dopamine centers of the reflexive brain. I call this human tendency ‘the predication addition’.”

This is how Jason Zweig describes the human tendency to predict in his book Your Money and Your Brain.

So do you suffer from prediction addiction?
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We learnt yesterday how the sunk cost fallacy leads investors to throw good money after bad.

Well, here’s what I read in a leading business daily that talks about the impending financial crisis in the western world:

“An apocalyptic Lehman-style moment seems unlikely right now, because US legislators will likely come to some sort of a deal that will allow the federal government to resume borrowing, while Europe has invested too much in the integration project to let things collapse in the first episode of stress.”

Note the words – “invested too much…to let things collapse”.

Now, this is a case of ‘sunk cost fallacy’ on a massive scale.

Pity the poor taxpayer!

Have you ever wondered why the anchors and the stock market experts on business channels make so many predictions day in and day out? And why they are so happy to make these predictions?

Or what gives you a natural high while predicting the future of the stock markets, or stocks you hold or are about to buy?

Neuroscientists lay the blame on ‘dopamine’ – a chemical in our brains that helps us figure out how to take actions that will result in rewards at the right time.

It’s the release of dopamine in our brains that gives us that high to make the next prediction, and the next one.

It gives us the pleasure of expecting our predictions to turn out true in the future. Like the pleasure you’d derive from predicting the Sensex over the next 12 months, and also expecting your call to turn out true!
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If yes, you will relate to this chart. If not, this is what overconfidence will do to you.

“First, expect to be wrong in the stock market.”

My friend Ravi had a puzzled look on his face. He asked me, “What are you saying Vishal? One has to always be right to survive in the stock market. And you want me to expect to be wrong?”

Ravi isn’t an exceptional case. I have seen so many other investors amazed when I ask them to expect to be wrong in the stock market.

You see, one of the most important traits of successful investors is that they recognize the frequency with which they can get ‘clean bowled’ – and thus they have a plan in place to deal with such situations.

This is the first lesson most new investors fail to digest, and thus neglect.
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