Are You A Good Investor?

by Elaine Schwartz    •    Nov 3, 2011    •    637 Views

Good investing takes us to our emotions. But not quite how you might expect.

Our brains don’t like random events. Instead, we prefer patterns, especially pleasing patterns. For basketball, that means streaks. According to one statistical study of the 76ers and the Boston Celtics, players do not really have “hot hands.” But our brains experience more pleasure when we attribute a streak to a player.

Similarly, for investing, because we perceive rising stock prices as a pattern, we feel pleasure. Then, for tech stocks, or gold, or houses, the higher the market goes, the more satisfaction participants get from being a part of its ascent. In fact, many of us get so much delight from our “dopamine rich” brain centers that we forget we could be in a bubble.

Consequently, as science writer Jonah Lehrer tells us in a Wired column, and in How We Decide, the quest for “lucrative patterns” when events are actually random can lead us astray. Maybe that is why “the best shooters always think they’re cold” and the best investors question a skyrocketing market.

The Economic Lesson

For his behavioral research, psychologist Daniel Kahneman won the Nobel Prize in Economics in 2002. Demonstrating that our decisions are more irrational than traditional economists tend to believe, Dr. Kahneman described the “systemic patterns” that we create when we respond illogically.

For example, his work displayed that we care more about losses than gains and the “frame” for a question shapes its answer. As a result, told that an investment of $1,000 could lose 50% people typically reject the idea. On the other hand, we tend to say, “Yes,” when told an investment could gain 50%.  Here, the NY Times ideally describes his work.

An Economic Question: Similar to basketball shooting streaks, where else have you seen people try to create patterns where none exist?

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