Discover the Behavioural Economics

The stock market expert and speculator André Kostolany once said that it´s better to study psychology than economics if you want to make money on the wall street. To explain what Mr. Kosolany meant with this assertion I want to show you a little example.

Imagine we trow a coin nine times, the first time we do that we receive the array of numbers (N) and heads (H) of N-N-H-N-H-H-N-H-N . The second try returns the sequence N-N-N-N-N-N-N-N-N.

So the question is which array is more probable? And if we look at the sequences most people would say that the first one is more plausible, the answer however is that they are stochastic equal. But what has this to do with investing? Well this little example tells us much about how people think. We are trying to see pattern where no patterns are, there are many people who have the same way of thinking by picking their stocks they try to see patterns. This is called representativeness heuristic and is one of the basics of behavioral finance.

The psychologist Daniel Kahneman got the Nobel price in 2002 for proving that irrational behavior in investment decisions can be attributed to special parts of our brain. In his experiments he lay probates in a MRI and asked them different questions about money. For example he asked if you would prefer to have 100 Dollar now or 110 in 4 month? The results of the tests were impressing, always the probands decided for getting the money immediately especially the hind brain was activated. When the probands decided for getting more money later the cerebrum made this decision. In the end Mr. Kahneman could prove that a large part of of investment decisions was controlled by mechanisms which originate from a time of eating and being eaten. Fight, attack and escaping are behavioral patterns which influence us till today. So our brain is thinkable improper for investment decisions, we build on the same mechanisms which also reptiles use for their daily life. But if you realize that you can really benefit from the manners of the others.