Sometimes a picture is worthless

By DAVID MOON, Moon Capital Management
April 17, 2005

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, solar-centered orbits.

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 pattern.

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).

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