STREET DOGS

Adapted from an article at Behavioural Investment:

Investors are often lured into a poor decision by a compelling story and no financial bubble in history has been without some beguiling narrative – yet, their importance is hugely understated.

The human brain’s reliance on narratives to make sense of the world means they define much of our investment behaviour. The noisy, chaotic and unpredictable nature of financial markets is anathema to our mind’s desire for order and clarity; stories reduce our discomfort and allow us to navigate ever-capricious waters.

Storytelling in financial markets is driven by cause and effect: either we predict a cause and effect before the event, or we look to rationalise an effect by defining a cause after it occurred.

In many other circumstances a straight line can be drawn from cause to effect even if something might not be forecastable, it can be understood after the event. Unfortunately, in the random and reflexive world of investment, we know only too well the hopelessness of forecasting and observe on a daily basis myriad competing explanations for even the most irrelevant market changes.

If gleaning cause and effect in financial markets is so difficult, why do we spend so much of our time doing it? The alternative would be to exist in a financial environment of randomness and chaos, and whilst this may be closer to reality, it would not make for a comfortable existence.

Unfortunately, for investors it is likely to mean overtrading, overconfidence, stress and partiality. Rather investors should be comfortable stepping away (it doesn’t matter what the market did yesterday or why), be willing to say they have no idea what will happen or why it happened; and focus on some robust, evidencebased, principles – all supported by a good story, of course.