Investment Decisions and Irrational Behaviour
SWAY: The Irresistible Pull of Irrational Behaviour, written by Ori and Rom Brafman, was first published in 2008. It was a New York Times bestseller. Full details below.
The book has nine chapters, all with the same basic format. Each chapter covers an aspect of irrational decision making. Several examples are given in each chapter, and then statistical analysis and/or psychological testing is used to explain the reason for the irrational behaviour.
I shall briefly review two chapters of the book:
Chapter Four: Michael Jordan and the First-Date Interview
In common with many sports, the US NBA (National Basketball Association) ranks new players in each year’s draft pick. The theory is that the higher the ranking, the more valuable the player. High draft picks are much sought after, and traded for. The ranking is, of course, only educated guesswork. But it is thought by many to be fact. Michael Jordan was not the number one pick in 1984. He was passed over by a number of teams in favour of higher draft picks.
Two economists, Barry Staw and Ha Hoang, used the vast store of NBA data to define players in three distinct areas; scoring (points per minute etc.), toughness (rebounds and blocks), and quickness (assists and steals). The objective was to relate player skills to career playing time.
The results were astounding. Only scoring related to playing time. Toughness and quickness were most closely related to draft position. This irrational behaviour is known as “diagnosis bias”.
With investing, this behaviour is most commonly seen when initial research leads to a stock purchase. Future negative information will be ignored because the investor is wedded to the initial decision. Diagnosis bias is part of why it is hard to sell a losing position.
Chapter Seven: Compensation and Cocaine
We need to delve into neuroscience for this chapter. But it won’t be painful.
The nucleus accumbens is a rather primitive part of the brain that is responsible for production of dopamine (desire) and serotonin (inhibition). Most pleasure drugs increase the production of dopamine and depress production of serotonin.
But dopamine is produced under a range of natural circumstances. Such as when a woman holds her baby, during sex, or eating, or making money. Importantly though, anticipation of pleasure also leads to raised dopamine levels.
Thus, thinking about the possibility of making money will release dopamine, causing pleasure, and reducing intellectual rigour. That is why some investors are seduced by the “make lots of money quickly” pitch.
This effect is referred to as “anticipation”. It feels like the money has already been made and we are thinking of how to spend it. The take-away for the investor is that contemplating a profitable trade will, perforce, cloud judgement.
Read the book. It is a little dry, but fascinating. We are all aware that humans act irrationality from time to time.. It is valuable to find out some of the reasons why.
SWAY: The Irresistible Pull of Irrational Behaviour
Ori Brafman and Rom Brafman, 2008
Published by Random House, Inc.
Buy it here