The human brain is reasonably well adapted to confrontation – we need only look at the “fight or flight” response which, through a surge in adrenaline not only jumpstarts alertness but also immediately prepares musculature for physical defense. What the brain doesn’t like, possibly above all other stimulus, is randomness, the consistent concern that some superior, little-understood force like disease, lightning or an overhead leopard could pop out of the sky at any time. SOAT described it thusly: “from the time we stood on two legs, exposing our internal organs in a way unlike any other mammal, the human brain has been oriented around fear.” For proof, he pointed to early polytheism where individual gods were assigned control over aspects of life like war, agriculture, love or the ocean, where people felt most beset by random factors. Sacrificing a goat before a long sea voyage or during planting seasons provided the illusion of control, decreasing the fear of a boat-swamping storm or hail that could wipe out a crop. The seductive notion of fate, that our futures are written in a book somewhere, is another central outgrowth of the way in which psychology struggles with random outcomes. At a subconscious level, we’d rather be under the control of a superior being than admit the full extent of luck and circumstance as a determining force.
Investing markets thus provide an interesting psychological challenge resulting from their daily, seemingly random volatility. Slitting the throats of unsuspecting farm animals being frowned upon in modern society, the coping mechanisms for this have evolved, and conspiracy theories are primary among them. The frustration of losing money in the market, exacerbated by its implications for future social status, can lead to a desperate form of pattern seeking where someone must be blamed. Finding a villain not only makes investing losses non-random and intelligible, but also provides a solution – burn that culprit at the stake and then I can be free to generate consistent, outsized returns before retiring to my own island in the Caribbean at age 45.
The reason I do not generally proscribe to conspiracy theories is not because I don’t believe there are groups powerful enough to design them. I just don’t think any group of people larger than ten is capable of keeping it quiet for longer than three months. Consider the Plunge Protection Team theory for a minute. It’s not hard to believe that Bernanke and Geithner would benefit, and have the means, to surreptitiously boost asset values in after hours trading. But, think also about how difficult it would be to keep this secret. These are huge trades and no investment bank is going to accept a $200 million check from an anonymous account to settle them. There will be inevitable clearing problems and if a Morgan Stanley back office clerk has to call a Langley Virginia area code and speak to someone who refuses to give their real name in order to sort them out, this information would spread to the trading floor, a place where rumors compete with oxygen in term of necessity, in less than 10 minutes. We’d know by now.
Conspiracy theories are not the only area where the human brain has been empirically proven to make us bad investors. The unchallenged king of sources for detailing them is the Psy-Fi blog. I can virtually guarantee that anyone who has made more than 20 trades in their lives can read Psy-Fi’s list of most common investor mistakes HERE, and recount making at least half of them. Don’t even bother emailing me if you think you haven’t – I’d sooner believe you’ve never had a craving for sugar or sex. In short, no investors’ education is complete without reading this list or a similarly detailed explication of investor psychology.
The market then, is not rigged against your investment success– you’re brain is. Every investor will look for patterns where none exist and blame the wrong people when it doesn’t work out. The same skepticism you show when a software salesperson comes into your office proclaiming to “improve productivity by 15%” will magically disappear when your broker calls. You will be sorely tempted to climb on market bandwagons late, after a huge run, because of a herding instinct perfectly adapted to the Neanderthal era. You will make important investment “sell” decisions based on the arbitrary price at which you bought the stock and you will fall in love with a current holding that is more likely to torpedo your portfolio than recover to book value. Your broker and the 1% are not to blame; they are just making it easy for you to do what your brain already wants you to.