Pavlov and investing? Any similarities?

"Common sense is the collection of prejudices acquired by age eighteen"

Albert Einstein

How true can that get? From a very young age, we were taught by our elders, by people to distinguish right from wrong, black from white, good versus evil and what not... Although most times, these teachings or values serve to protect us, to help us survive and thrive in society. But all too often, it builds within us a set of prejudices that goes beyond logic. Our reactions too become synchronised with the masses, being one with the crowd. Look at the division between the anglicans and the catholics in Ireland,the slavery and discrimination of the blacks in the US. Racism? Religious differences, racial differences and more all point to one thing and that is the different groups of shared ideology or herd mentality has been propagated throughout mankind for ages.

Pavlov, a russian scientist speaks about conditioning in scientific terms and his research included areas of temperament, conditioning and involuntary reflexes. When a dog hears the bell ringing with food placed outside the doghouse, it immediately knows that food awaits him. Through such conditioning, upon ringing of bells, the dogs start to salivate even without the aroma of food awaiting him. This is in fact a reflex action. Us human beings are like that too. We have been conditioned to react in certain manners due to the shared ideology that we have been brought up with. I take the Mass Rapid Transit to work everyday in singapore. Observe this and you will know that it is true. When there is a crowd of people alighting from the trains, there seems to be this mad rush for a few gantry exit points. Everyone squeezes out through these few gantry exits while you can spot other gantry exits available and unused. This, ladies and gentlemen is the herd mentality at work. Aren't we conditioned like dogs too if that's the case?

How does this apply to the stock market? It seems that as the indian and chinese stock markets are going up, more people want to join the band wagon. This effects a series of moves in the stock market that causes the stock market to be overvalued. India is trading at a PE of 55x while China is trading at a PE of 60x. Ridiculous but the higher it goes, the more the inflow of funds from investors, the herd. Contrastingly, when markets do correct everyone seems scared and panicky. In both scenarios painted above, it is most logical to underinvest when the markets are seemingly high and to be greedy when the markets are low for you get them at bargain prices.

Buffet speaks about this in his own way. He says: Be greedy when the market is fearful and fearful when the market is greedy.

Benjamin Graham too speaks about this. His analogy of Mr Market being a manic depressive is breeds familiarity among the value investing circles.

Tying it all together, i just like to put it in plain simple terms. Investing can be difficult because of social conditioning. It is more temperament that IQ. It reflects on the composure and awareness of an individual. The way a person looks at investments speaks volumes on a person's character as well. This game is simply a transfer of wealth from the person controlled by the herd to a person of awareness and composure. So ask yourself whenever you are about to make an investment decision. Am i part of the herd???? Just something to think about folks...



Better and better,
Lucas