By DAVID MOON, Moon Capital Management
Has your favorite team ever thrown an interception while you were away in the
restroom, prompting you to spend the rest of the game with an increasingly
swollen bladder, refusing to leave the action lest you cause another turnover?
As silly as it sounds, otherwise rational people consciously and unconsciously
find causes and patterns in life where none exist. Anthropological psychologists
call this sort of uncreative, repetitive behavior human sphexishness
Humans have a developed sense of accomplishment (compared say, to penguins)
because our scientific method of problem solving helps us identify the
predictable outcomes that follow certain events. It is our nature. Centuries
ago, man looked to the sky and learned to predict the future movements of the
stars and planets, without a full understanding of gravity or elliptical,
But finding patterns or causality is not always a good thing, particularly in
circumstances where they don't exist.
People do it in the stock market all the time. They "look at the chart" to
determine the future price movement of the stock. They might believe that if a
stock has gone up a bunch, then back down a little, then up a bunch, then back
down a little, that a pattern has developed and that the stock is about to go up
a bunch again.
Or they misbelieve that if a stock has had a steadily increasing price rise
over the last five years or more, the price will continue this trend. See GE and
Coca-Cola for two great contradictions to this myth. After steadily increasing
in price for 20 years, GE and Coke shareholders have more recently (five and
seven years) been rewarded with 40 and 55 percent losses, respectively. Nice
Imagine 500 people engaged in a contest of flipping a coin. In the first
round, 250 pairs of contestants compete against one another by flipping a
quarter and calling it in the air. After a few rounds, statistics show that one
person would remain as the only undefeated coin flipper. Is he a better coin
flipper than the other 499 contestants? Of course not. Someone had to be the one
remaining undefeated person. It was him. He was lucky. There is no causal
pattern involved, no matter how tempting it is to see one.
I have friends who collect knee surgeries the way some men collect baseball
caps. Every one of these guys (including me) is convinced that our knees ache
more when it is about to rain or at other times of significant weather changes.
We know it. We feel it in our bones.
But medical researchers say we are seeing patterns where none exist. There is
no reason for scar tissue to be any more bothersome in times of changing
humidity or temperature. But we associate the changes in weather with the aches
in our legs. When we get together and commiserate like whiny old ladies, we
reinforce this false belief. We convince ourselves of the existence of a pattern
that simply does not exist.
Think about that the next time you identify a pattern in the movement in the
price of a stock.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).