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LongView:Profitingfromtheirrational
Authers,John.FT.com (Jan30,2009).

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Wecanalwaysrelyonhumanirrationality.Whateverhappensinthemarketsandintheworldeconomy,people
willcontinuetodostupidthings.Thequestioniswhethertheywilldosopredictablyenoughfortherestofusto
takeadvantage.
Psychologicalresearchoverthepastthreedecadessuggeststhatwemaywellbe"predictablyirrational"that,
indeed,wasthetitleofanunlikelybestsellerlastyearbytheMassachusettsInstituteofTechnology'sDan
Ariely.Itdocumentedexperiments,mostlycarriedoutwithMIT'shighlyintelligentyoungstudentsasguinea
pigs,thatshowedhowtheywouldpredictablyfallvictimtowhatareknownasheuristicsmentalshortcuts
thathelpthemsurviveinthehurlyburlyofnormallife,butcanalsoleadthemintoirrationalitywhentryingto
makedecisionsinthefinancialrealm.
Thesepsychologicalinsightsunleashedsimilarexperimentsintheworldofinvestment.
OneofthemostrecentinthegenresawacademicsattheUniversityofIndianaexplorewhethertherewasa
"leftdigiteffect",instockprices*.Peoplereadnumbersfromlefttoright.Thus,asconsumermarketerslong
agodiscovered,youwillshiftmoreproductifthepriceendsin99.Whetherwelikeitornot,inaggregatepeople
behaveasthough$1.99ismuchmorethanonecentcheaperthan$2.
Afteranalysing100mtradesmadeontheNasdaqexchange,theywereabletoshowthatexactlythesame
phenomenonisatworkwhenpeoplebuystocks.Onaverage,"buy"ordersoutnumbered"sell"ordersby12per
centovertheperiodofthestudy.
Butatpricesendingin99,"buys"outnumbered"sells"by66percent.Itwasbyfarthemostpopularprice
pointatwhichtobuy.
Theleastpopularpricepointatwhichtobuywas01,wheretherewere0.83buyordersforeverysell.
Thesecondmostpopularpricepointatwhichtobuywas49andthesecondmostpopularatwhichtosellwas
51.
Atfirst,thismightimplythatweareallstupid.Morefairlytothehumanrace,itshowsthatwehavestructural
difficultiesgettingoverournaturaltendencytoreadnumbersfromlefttoright.
However,itdoesopeninvestmentpossibilitiesforthosewhocanfindwaystoexploitthosestructuraldifficulties.
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Italsosuggeststhatrigorouslyquantitativeinvestingusingcomputers,whichhashadabadpressaftersome
disastrousresultslastyear,mightstillhavearole.Computersarenotpreytoheuristics.
Anotherpersistentproblemisthatwehavedifficultyprocessinginformationpresentedtousasalistof
numbers,whereaswecanmorereadilyinterpretinformationshowntousasachart.Again,thisstemsfrom
mankind'soriginsonthesavannahourbrainsaretrainedtoprocessinformationpresentedtousvisually,
ratherthantoreadthroughlistsofnumbers.
Thisinturnmeansthatwhenweseeatrendpresentedtousasacurveonapieceofpaper,wefindithardnot
toextrapolatethatitwillcontinueinthesamewayinthefuture.
DanielKahneman,thepsychologistwhowasawardedtheNobelprizeforeconomicsin2002forhiswork
identifyingsystematicirrationalitiessuchasthisindecisionmaking,suggestedthatthistendencyhelpedcreate
theUShousingbubble.
LookingbackontimespentinCaliforniaasrealestatepriceswerebeginningtodetachfromreality,hesays:"It
takesverylittletimeforpeopletoperceiveatrendandtoassumethatitgoesforever."
Itispossibletoarguethatmuchthesamethingmaynowbehappeninginreverse.Manyindicatorsofeconomic
activity,includingthegrowthofgrossdomesticproductintheUS,haveinthepastfewmonthsfallenataspeed
thatisalmostwithoutprecedent.
Friday'sdeclineinUSGDP,at3.8percent,wastheworstsince1982.Buttheinstantresponseoftraderswas
asthoughthiswasgoodnews,becausetheyhadfearedevenworse.Again,ahyperrationalmachinemight
makemoneyfrombettingagainstresponsessuchasthis.
Havingidentifiedthatourcognitivefacultiescouldbeourownworstenemywhenitcomestoinvesting,the
problemremainshowtodealwithit.
Sadlyforourownsenseofindependence,Kahnemansuggeststhatitmightbeeasierforlargeinstitutionsto
overcometheseproblems,ratherthanindividuals."It'salmostcertainlythecasethatinstitutionshavebetter
meansofovercomingheuristics.Theideainparticularisthatindividualsaremoresensitivetonews.Ifyouare
anindividual,yourattentionwillbedrawntostocksthatareinthenews.Institutionsaremuchmorelikelyto
beabletoresistthis."
Ifnotentirelypredictable,humanirrationalityisaconstantonwhichwecanallrely.Andsoattemptstoexploit
itwillcontinue.But,littlethoughwemaytrustthemaftertheirfailingsofthelastyear,itmightbebesttoleave
ittofinancialinstitutionstodoit,ratherthantrytodoitourselves.
*UtpalBhattacharya,CraigW.Holden,andStaceyE.Jacobsen,'PennyWise,DollarFoolish:theLeftDigitEffect
inSecurityTrading'.AvailableatSSRN.
Credit:ByJohnAuthers
(CopyrightFinancialTimesLtd.2009.Allrightsreserved.)

Indexing(details)
Title

LongView:Profitingfromtheirrational

Author

Authers,John

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Publicationtitle

FT.com

Publicationyear

2009

Publicationdate

Jan30,2009

Year

2009

Publisher

TheFinancialTimesLimited

Placeofpublication

London

Countryofpublication

UnitedKingdom

Publicationsubject

BusinessAndEconomics

Sourcetype

TradeJournals

Languageofpublication

English

Documenttype

News

ProQuestdocumentID

229243896

DocumentURL

http://search.proquest.com/docview/229243896?
accountid=38148

Copyright

(CopyrightFinancialTimesLtd.2009.Allrightsreserved.)

Lastupdated

20100707

Database

ProQuestResearchLibrary

Copyright2015ProQuestLLC.Allrightsreserved.TermsandConditions

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