When it comes to markets, there appears to be a human tendency towards irrational exuberance:
Overconfidence
Instead of reacting to market rumors, anecdotes or advice with a healthy dose of skepticism, many people not only believe, but also act on what they hear, supremely confident that they are able to discern fact from fiction. Thinking that they know more than they do, they express their opinion as fact on subjects they actually know little about. Because admitting you don?t know something is considered a sign of ignorance, people would rather pretend to be confident and live with the consequences of being wrong. Instead of listening, they talk. Instead of learning, they lecture. Instead of waiting patiently, they act speculatively.
Irrational Exuberance
Robert J. Shiller
Magical Thinking
Magical thinking describes subjective speculation about how markets will act. It is difficult to know for sure how significant a role intuition about the likelihood that investments will do well or poorly plays in peoples? decisions to invest. We are trying to assess innermost thoughts about money and self worth which most people feel they do not have to explain or justify to anyone. However, we can label these patterns of thought as magical thinking. Most investors have occasional ?feelings or intuitions that certain trading actions will bring them luck even if they know logically the actions can have no effect on their fortunes. Playing a hunch just because it feels right seldom makes traders rich. Yet proof that it?s human nature to indulge in magical thinking abounds:
It has been shown that people will place larger bets on a coin that has not yet been tossed than on a coin that has already been tossed, but the outcome of the toss has yet to be revealed.
If asked how much money they would demand to part with a lottery ticket they already hold, most ticket holders give a figure over four times greater than if they themselves chose the lottery number on the ticket. Apparently, at some magical level people think that they can influence a coin that has not yet been tossed and influence the likelihood of winning the lottery by choosing the number.
People are capable of thinking, at least on some intuitive level, If I buy a stock, then it will go up afterwards or If I buy a stock, then others will probably want to buy the stock, too, because they are like me or I have a hot hand lately; my luck is with me. Such magical thinking is likely, in a subtle way, to contribute to the overconfidence that may help the propagation of speculative bubbles.
Irrational Exuberance
Robert J. Shiller
Shiller's book presents yet another correct view of the issues that so many people refuse to confront. These are the very issues that cause people to lose. Perhaps, one day investors will begin to appreciate uncertainty as something that can be managed. If people refrained from being overconfident or indulging in their magical thinking and then started to manage uncertainty as Trend Followers do -- there might actually be the risk of no more trends!
Is it likely? No. For trends to stop investors would need to realize that news, personal opinions, tips, etc. have no relevance to properly making a decision. Trend Following trading takes advantage of the psychological weaknesses that most people possess. Trend Followers disarm the magical thinkers by winning their losses in the great zero sum game.
Ponder the wisdom:
Everyone wants to be rich, but few want to work for it.
Richard Driehaus
NOTE: If you want to learn trend following techniques and systems through advanced home study and or seminars for all traders click here. If you want to learn about trend following trading in general there is one definitive text the bestselling classic "Trend Following: How Great Traders Make Millions in Up or Down Markets" by Michael Covel. If you want to learn about the most famous group of trained trend following traders, the Turtles and their teacher Richard Dennis, "The Complete TurtleTrader" by Michael Covel is the only complete biography (with all of the Turtle rules) available. Key introductions:
- Top Reasons to Be a Trend Follower.
- Can I become a trend follower?
- When the next crash happens will you be ready?
- The dead hand of safe bets.
- Trend Following preface.
- The Complete TurtleTrader preface.
- The Complete TurtleTrader afterword.
- On criticism.
- Meeting Mikhail Gorbachev: my journey.
- Influences.
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