I’ve venture to guess that the large majority of investors - particularly the professional ones - might admit to following their gut to some degree, but would still insist their decisions are informed and rational ones. But how different are their purchases and discards than a teen at the mall?

David Doubilet for National Geographic

Jason Zweig explores the latest attention getting scientific theory that everyone is talking about in his article for the Wall Street Journal, So That’s Why Investors Can’t Think for Themselves:

Why do investors so often seem to resemble a school of fish, all changing direction together?

…A study published last week in the journal Current Biology found that the value you place on something is likely to go up when other people tell you it is worth more than you thought, and down when others say it is worth less. More strikingly, if your evaluation agrees with what others tell you, then a part of your brain that specializes in processing rewards kicks into high gear.

In other words, investors often go along with the crowd because—at the most basic biological level—conformity feels good. Moving in herds doesn’t just give investors a sense of “safety in numbers.” It also gives them pleasure.

That may help explain why market sentiment can change so swiftly, why true contrarians are so hard to find and why investors care so much about the “consensus view” on Wall Street.

Most of our brains are programmed to reward us when we swim with the school.

The brain scans showed that as soon as people learned they had chosen the same song as the experts, cells in the ventral striatum—a reward center wired with dopamine neurons that respond to pleasures like sugar and sex—fired intensely.

“If someone agrees with your choice, it’s intrinsically rewarding in the same way food or money is rewarding,” says one of the experimenters, Chris Frith of University College London.

Why might other people’s estimates of what something is worth lead you to change your own? Their appraisal could make you unsure that yours is correct. You might become more popular once you agree with others, or joining the experts may make you feel like one yourself. “We are very social creatures,” says Prof. Frith, “and we are desperately keen to be part of the group.”

In 1969 sociologist Herbert Blumer was the first to publish a theory that the fashion mechanism operated in all fields of human endeavor, not just clothing. I’ve included these quotes from his theory of collective selection (this blog’s namesake) in a previous post on how most economists were fashion victims of their own thinking and completely failed to predict the crash of 08, but they’re so good they bear repeating (emphasis my own):

It is necessary, first of all, to insist that fashion is not confined to those areas, such as women’s apparel, in which fashion is institutionalized and professionally exploited under conditions of intense competition. As mentioned earlier, it is found in operation in a wide variety and increasing number of fields which shun deliberate or intentional concern with fashion. In such fields, fashion occurs almost always without awareness on the part of those who are caught in its operation. What may be primarily response to fashion is seen and interpreted in other ways – chiefly as doing what is believed to be superior practice.

Not only are most investors (and artists and psychiatrists and economists) blind to their immersion in the fashion mechanism, they get downright offended when you propose that their decisions are informed by anything short of ’superior practice.’

…The absence or inadequacy of compelling tests of the merit of proposals opens the door to prestige-endorsement and taste as determinants of collective choice. The compelling role of these two factors as they interact easily escapes notice by those who participate in the process of collective choice; the model which emerges with a high sanction and approval is almost always believed by them as being intrinsically and demonstrably correct. This belief is fortified by the impressive arguments and arrays of specious facts that may be frequently be marshaled on behalf of the model. Consequently, it is not surprising that participants may fail to completely to recognize a fashion process in which they are sharing. The identification of the process as fashion occurs usually only after it is gone – when it can be viewed from the detached vantage point of a later time. The fashions which we can now detect in the past history of philosophy, medicine, science, technological use and industrial practice did not appear as fashions to shoes who shared in them. The fashion merely appeared to them as up-to-date achievements!

Zweig sums up more on the brain chemistry behind this:

The experiment also showed that learning that the experts agree with one another—regardless of whether you agree with them—triggers activity in the insula, a brain region associated with pain and heightened body awareness. This suggests that the agreement of others may have a special ability to grab our mental attention. No wonder a consensus opinion is almost impossible for many investors to ignore.

He also calls out the myth of the market as a rational and impersonal mechanism:

Benjamin Graham, the founder of value investing, wrote that “the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities.” Rather, he added, “the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.” Herding, Graham understood, is part of the human condition.

Zweig’s prescription? Do everything you can to go against the herd and establish tracking mechanisms for your decisions to go back and evaluate more objectively:

Thus, if you buy individual stocks, you should note which way the herd is moving—and go the other way. You should get interested in a stock when its price gets trampled flat by investors stampeding out of it. The list of new 52-week lows is a rough guide to what the voting machine has been trashing lately. Then run your own weighing machine, studying the company’s financial statements, products and competitors to determine the value of its business—while ignoring the current price of its stock. And make a permanent record that thoroughly details your rationale for making the investment. That way, you set in stone exactly where you stood before the herd began trying to sweep you away.

I happened upon on a succinct and thought provoking post on attention, consciousness and how the internet is affecting the two. The host site, Edge.org, introduced me to the term ‘The Third Culture:’

The third culture consists of those scientists and other thinkers in the empirical world who, through their work and expository writing, are taking the place of the traditional intellectual in rendering visible the deeper meanings of our lives, redefining who and what we are.

Thomas Metzinger, a self described ‘neuro-philosopher,’ is the author of The Ego Tunnel: The Science of the Mind and the Myth of the Self:

The core of the problem is not cognitive style, but something else: attention management. The ability to attend to our environment, to our own feelings, and to those of others is a naturally evolved feature of the human brain. Attention is a finite commodity, and it is absolutely essential to living a good life. We need attention in order to truly listen to others — and even to ourselves. We need attention to truly enjoy sensory pleasures, as well as for efficient learning. We need it in order to be truly present during sex, or to be in love, or when we are just contemplating nature. Our brains can generate only a limited amount of this precious resource every day. Today, the advertisement and entertainment industries are attacking the very foundations of our capacity for experience, drawing us into the vast and confusing media jungle. They are trying to rob us of as much of our scarce resource as possible, and they are doing so in ever more persistent and intelligent ways. We know all that. But here is something we are just beginning to understand — that the Internet affects our sense of selfhood, and on a deep functional level.

Consciousness is the space of attentional agency: Conscious information is exactly that information in your brain to which you can deliberately direct your attention. As an attentional agent, you can initiate a shift in attention and, as it were, direct your inner flashlight at certain targets: a perceptual object, say, or a specific feeling. In many situations, people lose the property of attentional agency, and consequently their sense of self is weakened. Infants cannot control their visual attention; their gaze seems to wander aimlessly from one object to another, because this part of their Ego is not yet consolidated. Another example of consciousness without attentional control is the non-lucid dream state. In other cases, too, such as severe drunkenness or senile dementia, you may lose the ability to direct your attention — and, correspondingly, feel that your “self” is falling apart.

If it is true that the experience of controlling and sustaining your focus of attention is one of the deeper layers of phenomenal selfhood, then what we are currently witnessing is not only an organized attack on the space of consciousness per se but a mild form of depersonalization. New medial environments may therefore create a new form of waking consciousness that resembles weakly subjective states — a mixture of dreaming, dementia, intoxication, and infantilization. Now we all do this together, every day. I call it Public Dreaming.

From American Radio Works: "The brain scan on the left shows an active insula - a pain center - of a research subject considering a price. On the right is a brain scan of a research subject looking at a desirable product. The nucleus accumbens - a pleasure center the brain - is active." - Courtesy of Scott Rick

What I love about all this is that we finally have hard scientific proof that contradicts the hyperconsumer capitalist/advertising industry defense against claims of manipulation that goes something like ‘we are all rational beings making choices for our own best interest based on objective information.’

Chris Julin writes Tightwads and Spendthrifts:

New research like Scott Rick’s is displacing some traditional ideas about economics that reach back more than 200 years, back to Adam Smith and the other founders of modern economics. According to classical economic theory, we are perfectly rational when we make economic decisions such as whether to buy a nifty new pair of shoes. Classical economics pays no attention to how we feel when we shop.

…in a sense, it’s pleasant to shop, but it hurts to pay.

“If it doesn’t hurt so much, and if I think I’ll like it, then I’ll buy it,” Rick says. “But if it really hurts, then that’s sort of a signal that we give ourselves not to buy.”

And Scott Rick isn’t the only one displacing classical, quantitative economic theory. In an earlier post I wrote about the upheaval in the field of economics revealed Blumer’s fashion mechanism at work as the revered experts who scoffed at the behavioral economists had their predictions blown out of the water with the economic meltdown they didn’t see coming. And apparently there’s been another group lurking on the fringes and just now gaining widespread recognition - neuroeconomists. (more…)