Friday, July 2, 2010

Why Can't Investors Think for Themselves?

The always awesome Jason Zweig unearths a new study that tells us why investor sentiment seems to change on a dime.

Sometimes the most interesting answers to financial questions come from scientific labs. A study published last week in the journal Current Biology found that the value you place on something is likely to go up when other people tell you it is worth more than you thought, and down when others say it is worth less. More strikingly, if your evaluation agrees with what others tell you, then a part of your brain that specializes in processing rewards kicks into high gear.

In other words, investors often go along with the crowd because—at the most basic biological level—conformity feels good. Moving in herds doesn't just give investors a sense of "safety in numbers." It also gives them pleasure.

Humans of course seek to maximize pleasurable behavior and thus go along with the crowd. Benjamin Graham, the father of value investing, long tried to convey this bit of behavioral wisdom to investors when he wrote "the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities."

Some of the worst violations of common sense are rationalized with the simple phrase "everyone else is doing it."

Continue Reading @ The Wall Street Journal