I have been rereading parts of Dan Ariely’s The Upside of Irrationality. For those who don’t know of Ariely and his work you can catch up with him on TED. One of the great cognitive biases we face as traders is the notion of herding – that is we run in groups. Institution’s are particularly prone to herding which is probably one of the reasons why corruption becomes institutionalized within an organization. If we see another trader doing something dim we are prone to follow them.
My guess is that it is also perhaps a partial reason why the performance of investment institutions tends to cluster – they all end up in the same stocks. As a broker I lost count of the number of times I saw various funds each buying the same stocks a few days apart from one another.
However, Ariely presents a different face to the notion of herding and that is herding at the level of the individual. He gives the following example.
Imagine that something happens that makes you feel happy and generous – say, your favorite team wins the World Series. That night you are having dinner at your mother-in-law’s and, while in this great mood, impulsively decide to buy her flowers. A month later, the emotion of the big win has faded away and so has the cash in your wallet. It is time for another visit to your mother-in-law. You think about how a good son-in-law should act. You consult your memory, and you remember your wonderful flower-buying act from your last visit, so you repeat it. You then repeat the ritual over and over until it becomes a habit (and in general this is not a bad habit to fall into). Even though the underlying reason for your initial action (excitement over the game) is no longer present, you take your past actions as an indication of what you should do next and the kind of son-in-law you are (the kind who buys his mother-in-law flowers). That way, the effects of the initial emotion end up influencing a long string of decisions.”
Your behavior is being guided by your previous actions the interesting thing is that it doesn’t seem to matter about the scale of the previous decision. Each decision has the potential to guide future behavior and therefore establish itself as a habit or repeating pattern of behavior.
Consider this within the context of trading; trading is effectively a habit-based profession. Professional traders do the same thing in the same way every day. There is no variation to this routine because the past success of this routine is guiding their daily behaviours. In effect they are self-herding there way to success. Contrast this with an unsuccessful trader who also self-herds but does so to a random series of inputs. Their decisions are based upon something they saw on tv, a snippet from a chat room or the phases of the moon. They have also established a pattern but it is not one directed at success.
The intriguing this about self-herding is that it has been recognized for millennia –
“Such as are your habitual thoughts, such also will be the character of your mind; for the soul is dyed by the thoughts.” – Marcus Aurelius
However, the reason I think it doesn’t really stick is that it throws the focus back on the individual and places them at the centre of their own universe of habits. And the last thing you want to do is tell people they are responsible for their own lives.