PBS puts together some really interesting stuff. This segment, titled “Your Mind and Your Money-Herd Mentality,” is worth reading or watching for those interested in how psychological misjudgments impact investors. I'm a huge fan of Michael Mauboussin
Here are some excerpts
PETERSON: Herding is a response to having not enough information and thinking that others around us can actually give us a shortcut to how to make a decision.
GRECH: So, studies of the brain confirm that people are very sensitive to peer pressure, but some people are able to withstand that pressure. They're not afraid to go against the crowd. They're called iconoclasts. Among investors, Warren Buffett is an iconoclast. He often goes against conventional wisdom on Wall Street. Peterson says being an iconoclast may seem risky, but it's often profitable.
MICHAEL MAUBOUSSIN, ADJUNCT PROFESSOR, COLUMBIA BUSINESS SCHOOL, AUTHOR, THINK TWICE: Yeah, how smart you are doesn't matter because we all come with the same mental software. And there is one bias that all of us share, whether your smart or not as smart and that is a tendency to extrapolate. So what we — if we've seen good results, we think they're going to go on forever. If we've seen something bad, we think it's going to go on forever. And that leads to what I think is the biggest mistake in investing, which is failure to distinguish between fundamentals and expectations. Fundamentals, basically how the company is going to perform in terms of sales and profits and expectations is what's embedded in the stock price. Those are two really different things and you have to look for the disconnects and where the market's mis-pricing expectations. That's the key — the key task for investors.
HUDSON: Michael, what about kind of ignoring the crowd, ignoring that herd and having the courage and the confidence to say you think maybe the market's wrong.
MAUBOUSSIN: To be a really great investor, you first do need to be a contrarian. So you have to be going against the crowd. But let just me be really clear about this. Being a contrarian for the sake of being a contrarian is not a good idea. In other words, when the movie theater's on fire, run out the door, right? Don't run in the door. But once you identify a situation where you think you can be a contrarian, then there's a second test. The second test is going back to what I mentioned at the outset, measuring the difference between fundamentals and expectations. Because if the crowd takes something to an extreme, either on the bullish side or the bearish side, that should show up in your disconnect between fundamentals and expectations. And that is what allows you to make a good investment.
MAUBOUSSIN: If I could just jump in. First of all, I want to echo want Denise said. I think that's absolutely correct. When you're faced with certain types of situations as an investor or any kind of professional, your mind is often going to take you down one path, when a better way to think about that problem is a different way. So, I would also say learning about these kinds of situations and learning where you're likely to wrong, can be very, very helpful. So, again, it's not that you should be non-emotional, or not be aware of your emotions, it's to be tuned into that and sort of recognize when you walk into potential decision- making danger zones.
Michael Mauboussin is the author of More More Than You Know: Finding Financial Wisdom in Unconventional Places and more recently, Think Twice: Harnessing the Power of Counterintuition.