Investingg Psychology The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to ecommerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more For a list of available titles, visit our Web site at www.WileyFinance.com Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding Investingg Psychology The Effects of Behavioral Finance on Investment Choice and Bias TIM RICHARDS Creator of the Psy-Fi Blog (www.psyfitec.com) Cover image: ©iStochphoto.com/AmandaRuch ©iStochphoto.com/fatido Cover design: Wiley Copyright © 2014 by Tim Richards All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 6468600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Library of Congress Cataloging-in-Publication Data: Richards, Tim, 1961Investing psychology : the effects of behavioral fi nance on investment choice and bias / Tim Richards pages cm.—(Wiley fi nance series) Includes bibliographical references and index ISBN 978-1-118-72219-0 (cloth) Investments—Psychological aspects Finance—Psychological aspects I Title HG4515.15.R53 2014 332.601’9 dc23 2013050096 Printed in the United States of America 10 To Skyla, Alexa, and Hallie; for being there always, as I will always be here for you Contents Preface CHAPTER Sensory Finance Beating the Bias Blind Spot Illusory Pattern Recognition Superstitious Pigeons—and Investors The Super Bowl Effect: If It Looks Too Good to Be True, It Is Your Financial Horoscope: Forecasting and the Barnum Effect Uncertainty: The Unknown Unknowns Illusion of Control Stocks Aren’t Snakes Herding Availability Assuming the Serial Position Hot Hands Financial Memory Syndrome Attention! The Problem with Linda Representation The Seven Key Takeaways Notes CHAPTER Self-Image and Self-Worth The Introspection Illusion Blind Spot Bias, Revisited Rose-Colored Investing Past and Present Failures Depressed but Wealthy xiii 1 10 12 13 15 16 19 21 23 25 27 29 31 33 34 37 37 39 40 41 43 vii viii CONTENTS Disposed to Lose Money Loss Aversion Anchored Two Strangers Hindsight’s Not So Wonderful Deferral to Authority Emotion Black Swans Dirty Money, Mental Accounting A Faint Whisper of Emotion Psychologically Numbed Martha Stewart’s Biases Retrospective Annual Returns Nudged Mindfulness The Seven Key Takeaways Notes CHAPTER Situational Finance Disposition vs Situation Beauty Is in the Eye of the Investor Angels or Demons? Merely Familiar Lemming Time Story Time Wise Crowds? Adaptive Markets George Soros’s Reflexivity Grow Old Quickly Speaking Ill The Power of Persuasion SAD Investors Sell in May The Mystery of the Vanishing Anomalies Tweet and Invest Fire! The Rise of the Machines The Seven Key Takeaways Notes 44 45 46 48 50 51 52 54 55 56 57 58 60 60 61 62 65 66 69 69 70 71 73 74 76 78 79 81 82 83 85 86 87 89 90 92 93 94 95 About the Companion Website T his book includes a companion website, which can be found at www wiley.com/go/investpsych The website includes a set of worksheets and guidance for the following toolkits: Behavioral Investing Toolkit 1: Mission Statement Behavioral Investing Toolkit 2: Investment Thesis Behavioral Investing Toolkit 3: Investing Checklist Behavioral Investing Toolkit 4: Feedback Behavioral Investing Toolkit 5: Diarize Reviews Behavioral Investing Toolkit 6: Autopsy Behavioral Investing Toolkit 7: Update The website also includes a spreadsheet that extracts the main lessons from the book To access the site, go to www.wiley.com/go/investpsych (password: behavioral) 227 About the Author TIM RICHARDS is a polymathic student of the investing sciences; originally a physicist, later a computer system designer involved in technology that will be in most readers’ pockets and purses (mobile phones and chip-based credit cards), then a psychologist and always an investor, Tim has spent years analyzing the weird and wonderful behavior of investors, fund managers, securities analysts, and all of the associated members of the global investing community Tim is the creator of the behavioral finance-based website, The Psy-Fi Blog, where he brings his wide-ranging experience and wryly cynical world view to bear on the weird and wonderful world of finance The Psy-Fi Blog offers a unique insight into the application of behavioral finance, through reference to a growing body of research that shows conclusively that we are not as smart as we think we are By linking behavioral finance research to real-world events and showing their connections to other areas of knowledge, Tim constantly aims to remind us that the only proper way of living is to seek knowledge beyond our comfort zones Tim lives in the United Kingdom with a scruffy dog and a rotating group of daughters, who take turns attempting to look after him He’s still alive, so he reckons they’re doing a pretty good job under the circumstances 229 Index Abductions, child, 20, 34–35 Accruals, 89–90, 91, 205 Adaptive Markets Hypothesis, 80, 90 Adverse selection, 120 Advice, challenging, 205, 224 Affect heuristic, 56–58, 101–102, 178–179 Age, 82–83 Airely, Dan, 47, 107 Akerlof, George, 105, 120, 149, 150 Aknin, Lara, 125 Alter, Adam, 74 Altruism, 141–142 Amabile, Teresa, 44 Amir, On, 209 Ananth, Bindu, 211 Anchoring, 46–48, 147 Anecdotal evidence, 19, 58, 223 Anginer, Deniz, 178 Annual autopsies, 200 Annual reports, 159–160 Anomalies, 89–92, 177 Arkes, Hal, 177 Armstrong, J Scott, 139 Arnott, Rob, 216 Asch, Solomon, 99–100 ASOS (Internet retailer), 64 Aspara, Jaakko, 178–179 Asymmetric, differential price discovery, 135 Asymmetry, information, 120, 121, 213 Attention, 27–28, 221 Authority, deferral to, 39–40, 44, 51–52 Autism, 58, 116 Automated trading, 89, 93–94, 134–135, 174 Autopsies, 199–200 Availability: anchoring and, 48 cognitive repair for, 181, 202 hot-hands effect and, 24–25 noise traders and, 79 problems caused by, 223 recency effect and, 21–23 representative heuristic and, 31–32 salience and, 19–21 Avnaim-Pesso, Liora, 209 Babe Ruth effect, 54, 81 Backfill bias, 132 Backfire effect, 49, 102 Baker, Michael, 143 Balance sheet, 160 Bandura, Albert, 107 Bangladeshi butter production, 91 Barber, Brad, 41, 55–56, 78, 140, 151 Bargh, John, 30 Barnum, P.T., 11 Barnum effect, 10–12 Baron-Cohen, Simon, 116 Base rate neglect, 31–32, 162 Baumeister, Roy F., 209 Beauty contest investing, 117, 123 Beauty effect, 44 Beauty premium, 70–71 Behavioral Investing Framework, 192–201 about, 192–193 autopsies, 199–200 checklist, 195–196 feedback, 198–199 investment thesis, 196–197 personal investing mission statement, 193–195 reviews, scheduling, 197–198 updating adaptively, 200–201 Behavioral portfolios, 110–112 Bénabou, Roland, 101 Bergstresser, Daniel, 107, 146 Bernstein, Peter, 216 Bernstein, William, 166 Beunz, Daniel, 115 Bhattacharya, Debarati, 161 231 232 Biddle, Jeff, 70 Black, Fischer, 78 Black-Scholes model, 144–145 Black Swans, 54–55 Blind spot bias, 1–4, 39–40, 202, 224 Blumer, Catherine, 177 Bollen, Johan, 90–91 Books, investing self-help, 223 Booth, Richard, 150 BP’s Deepwater Horizon, 17, 138 Bracha, Anat, 76 Brain damage, 53 Brown, Lawrence, 137 Bruner, Robert, 147 Bryan, Christopher, 125 Buffett, Warren, 215 Butterfly effect, 80, 137 Butter production, Bangladeshi, 91 Buybacks, share, 148–149 Byrne, Richard, 118 Bystander effect, 124–125 Carpenter, William, 30 Carveth, Rodney, 101 Central Intelligence Agency (CIA), 50 CEO compensation, 107, 146, 148 Cervellati, Enrico, 138 Challenger (Space Shuttle), 100–101, 202–203 Checklists, 28, 63, 177–178, 195–196, 203 Child abductions, 20, 34–35 CIA (Central Intelligence Agency), 50 Cialdini, Robert, 85, 120 Clare, Andrew, 167 Clever Hans (horse), 116 Cleverness, excessive, 64 Cognitive repairs, 180–181 Coin tossing, 14, 23–24 Columbia (Space Shuttle), 101 Comley, Pete, 151 Commitment bias, 177, 178 Compensation, CEO, 107, 146, 148 Complementarities, 75–76 Composition, fallacy of, 92–93 Confirmation bias, 139, 167–168, 189–190, 202, 218 Conformity, group, 99–100, 101 Conformity test, 99–100 Conjunction fallacy, 29–30 Contracts, 152 INDEX Contrarianism, 160–161, 162–163 Contrast principle, 85 Control, illusion of, 13–15 Conversational bias, 83–84 Cooper, Michael, 72 Corp, Nadia, 118 Corporate affect heuristic, 178–179 Corruption hypothesis, 150 Cowles, Alfred, 42, 51 Crowds, wisdom of, 78–79 Damasio, Antonio, 53 Daniel, Kent, 49 Danziger, Shai, 209 Dark pools, 135 Dawkins, Richard, 113 De Bondt, Werner, 61, 138, 162 De Bondt-Thaler hypothesis, 61 Debt, avoiding, 215–216 Deceit, 118, 119–120 December effect, 59 Decision trees, 169–170 Decoy effect, 209 Deepwater Horizon, 17, 138 Deferral to authority, 39–40, 44, 51–52 De la Vega, Joseph, 75 DeMarzo, Jeffrey, 84 Dempsey, Melanie, 73 Depressive realism effect, 43 Derivatives, 144–145 Derman, Emanuel, 144 Dhar, Ravi, 209 Dimitrov, Orlin, 72 Dimson, Elroy, 216 Disappointment aversion, 216 Disaster myopia, 54–55 Disconfirming, 167–168, 224 Disengagement, moral, 107–108 Disposition effect, 39–40, 44–45, 45–46, 82–83, 201 Diversification, 165–167, 204 Dividends from stocks, 112–113 Diworsification, 165–167 Dolan, Raymond, 139, 218–219 Dopamine, 141–142 “Do Security Analysts Overreact?” (de Bondt and Thaler), 138 Dot-com era, 72, 74–75, 150, 166 Dowd, Kevin, 176 Dread risk, 18–19 233 Index Driving skills, 39, 48–49 Dunn, Elizabeth, 125 Dunning, David, 218 Dunning-Kruger effect, 218, 224 Durand, Robert, 140 Earnings forecasting, 136, 137–138 Easy data bias, 132 Ecological validity, 182 Economic reflexivity, 81–82 Efficient Markets Hypothesis, 80, 111, 132, 152, 161, 165 Ego depletion, 209 Eisenberger, Naomi, 77 Ekman, Paul, 118 Electrocution test, 39–40, 44, 51 Embeddedness, 114–116 Emotion, 52–53, 56–58, 101–102, 178–179, 202 Equity premium, 216–217 Evidence, anecdotal, 19, 58, 223 Exceptions, 63–64 Expected value, 171–172 Experience, 82–83 Facebook, 123 Failures, 62–63, 173, 176 “Faint whisper of emotion,” 56–58, 101–102, 178–179 Fairness, 118–119 Falk, Armin, 118–119 Fallacy of composition, 92–93 Fallibility, principle of, 81 False memory syndrome, 26 Familiarity, 73–74 Feedback, 173, 191–192, 198–199, 212, 224 Fees, 205 Fehr, Ernst, 118–119 Fen, Yang, 133, 134 Ferraris, Claire, 101 Feynman, Richard, 100–101, 202–203 Fiduciary duty, 152 Fielding, David, 216 Financial education, limitations of, 213–214 Financial memory syndrome, 25–27 Financial numeracy, 212 Fischbacher, Urs, 118–119 Fischhoff, Baruch, 50, 51 Fisher, Kenneth, 178 Flash-crashes, 135 Fluency, 73–74 Flying, 13, 20 Focusing illusion, 210 Forecasting, 11–12, 17, 51, 136–140, 173 Forer, Bertram, 11 Framing, 108–110, 125, 202, 205, 210 Frequencies, observed, 5, 31 Fundamental attribution error, 45 Future self, 125 Galinsky, Adam, 5–6, 145 Galton, Francis, 78, 162 Gambler’s fallacy, 22–23 Game show hosts, 44, 70 Gaming the system, 106–108 Ganzach, Yoav, 57 Gearing, 215–216 Gender differences in investing, 140–141, 143 Genovese, Kitty, 124 Gigerenzer, Gerd, 180, 181, 182 Gilad, Dalia, 30 Gilbert, Daniel, 102 Glaser, Markus, 8, 41 Goetzmann, William N., 50 Goffman, Erving, 108 Golfers, professional, 45–46 Goyal, Amit, 137 Graham, Ben, 20, 139 Granovetter, Mark, 115 Griffin, Paul, 148 Group conformity, 99–100, 101 Group polarization, 103–104, 168–169 Groupthink, 100–101 Guyon, Dan, 41–42 Hackethal, Andreas, 43 Halloween effect, 88 Halo effect, 71–73, 202 Hamermesh, Daniel, 70 Handicaps, 122 Hannah, Leslie, 169 Happiness, 210–211 Harmon, Dion, 75 Heath, Chip, 180–181 Heimer, Randy, 123–124 Herding, 16–18, 74–76, 78, 139, 202 Hersfield, Hal, 125 High-frequency trading, 134–135 Hill, Theodore P., 24 234 Hindsight bias, 50–51, 54, 172–173, 202 Hirota, Shinichi, 112 Hirshleifer, David, 49, 123 Horoscopes, 10–11 Hot-hands effect, 23–25 Identity, social, 104–105 Ideomotor effect, 30 Idiosyncratic risk, 143 Illusion(s): of control, 13–15 focusing, 210 introspection, 37–38, 39 money, 217 Moses, 73–74 Müller-Lyer, 1–3 seersucker, 139 visual, 1–3, 4–5 Illusory pattern recognition: about, 4–6 Barnum effect as form of, 10–12 hot-hands effect and, 24 reinforcement and, 6–8 “Impossibility of Faking Data, The” (Hill), 24 Incentives, 105, 107 Index funds, 133–134 Inflation, 217 Influence (Cialdini), 85 Information asymmetry, 120, 121, 213 Information overload, 26–27, 28, 187–188 Initial public offerings (IPOs), 149–150, 205 Instant history bias, 132 Institutional investment, 134–136, 224 Intermediate autopsies, 200 Intermittent reinforcement, 7–8 Interpretations, 63 Introspection illusion, 37–38, 39 Investing See also specific topics beauty contest, 117, 123 books, self-help, 223 checklist for, 195–196 gender differences in, 140–141, 143 institutional, 134–136, 224 mechanics of, 204–206 mission statement for, 105–106, 193–195 momentum, 121, 161–162, 170 Investment institutions, 90, 93–94 Investments, reviewing, 197–198 Investment thesis, 196–197, 203 INDEX Iowa Gambling Task, 53, 54 IPOs (initial public offerings), 149–150, 205 Iyengar, Sheena, 187 Jacobson, Ben, 88 Janis, Irving, 100 January effect, 87, 88 Jegadeesh, Narasimhan, 161 Joint attention, 221 Kahneman, Daniel, 29, 44, 109, 210 Karlan, Dean, 211 Keusch, Thomas, 159 Keynes, John Maynard, 117, 177 Kilger, Doron, 30 Kindleberger, Charles, 214 Kipling, Rudyard, 49 Kirmani, Amna, 121 Klayman, Joshua, 180–181 Knight Capital Group, 135 Koestner, Maximilian, 43 Korn, Christoph, 139, 218–219 Kramer, Lisa, 87 Kranton, Rachel, 105 Kruger, Justin, 218 Kugler, Matthew, 3–4, 39 Kumar, Alok, 109 Kuran, Timur, 84 Lakoff, George, 108–109 Lammers, Joris, 145 Langer, Ellen, 14, 59 Langford, Dale, 170–171 Language, 113–114 Larrick, Richard, 180–181 Lee, Yi-Tsung, 151 Leinweber, David, 91 Lemons, Akerlof’s, 120, 149, 150 Lepper, Mark, 187 Levav, Jonathan, 55, 209 Li, Feng, 160 Lieberman, Matthew, 77 Lim, Sonya, 109 Linda problem, 29–30, 31–32 Linnainmaa, Juhani, 82 Lo, Andrew, 80, 90 Locke, Peter, 46 Loftus, Elizabeth, 26 Lorenz, Edward, 136–137 Loss aversion, 45–46, 170–171, 201, 216 235 Index Losses, 150–151, 224–225 Lottery-insurance behavior, 110–112 Loughran, Tim, 150 Lui, Yu-Jane, 151 Lusardi, Annamari, 212 Lying, 118, 119–120 Madoff, Bernie, 9–10 Magicians, 221 Malkeil, Burton, 132 “Managing Overconfidence” (Russo and Shoemaker), 173 Maner, Jon, 143 Manias, Panics, and Crashes (Kindleberger), 214 Mann, Steven, 46 Mao, Huina, 90–91 Market failure, 120 Markowitz, Harry, 111, 165 Marquering, Wessel, 88 Marriage, 142–143 Marsh, Paul, 216 Masculinity, 140 Mass media, 18–19, 77, 168–169 Math skills, 212 Matsumoto, Dawn, 137 McAdams, Dan, 113 McGraw, Peter, 55 Mean reversion, 162–163, 170, 205 Media, mass, 18–19, 77, 168–169 Meeker, James, 164 Memes, 113–114 Mental accounting, 55–56, 110, 190, 201 Mergers and acquisitions (M&A), 147 Meta-methods, 189 Meyer, Steffen, 43 Milgram, Stanley, 39–40, 44, 51 Miller, George, 188 Mind, theory of, 116–118 Mindfulness/mindlessness, 59, 62–64 Mischel, Walter, 191 Mission statement, personal investing, 105–106, 193–195 Mitchell, Andrew, 73 Moats, 170, 194, 205 Momentum investing, 121, 161–162, 170 Money illusion, 217 Montier, James, 138 Moore, Don, 52 Moral accounting, 55 Moral disengagement, 107–108 Morck, Randall, 133, 134 Moses Illusion, 73–74 Motivated reasoning, 101–102 Motson, Nick, 167 Mullainathan, Sendhil, 211 Müller-Lyer illusion, 1–3 Mutual funds, 131–134 Mutually Assured Delusion principle, 101 Myopia, disaster, 54–55 Myths, 210–219 Narratives, 76–77, 153, 202, 223 Nelson, Richard, 122 Newby, Rick, 140 Nickerson, Raymond, 167 Niessan, Alexandra, 140 9/11 Twin Towers attack, 13, 20 Nisbet, Richard, 71–72 Noise traders, 78–79, 90–91 Norton, Michael, 125 Nudge theory, 61–62 Numbers, focusing on, 159–160 Numbing, psychophysical, 57–58 Numeracy, financial, 212 O’Brien, Ken, 105 Observed frequencies, 5, 31 Observer bias, 54 Odd events, sensitivity to, 63–64 Odean, Terrance, 41, 55–56, 78, 140, 151 O’Donoghue, Ted, 125 O’Neal, Edward, 167 Oppenheimer, Daniel, 74 Optimism, unrealistic, 40–44, 138–140 Options, share, 144–145, 146, 148 O’Sullivan, Maureen, 118 Overconfidence, 40–41, 43–44, 52, 172–173, 201, 218 Overload, information, 26–27, 28, 187–188 Overoptimism, 40–44, 138–140 Over precision, 52 See also Overconfidence Overtrading, 205, 224–225 Panics, 214–215 Pareidolia: about, 4–6 Barnum effect as form of, 10–12 hot-hands effect and, 24 reinforcement and, 6–8 236 Pariser, Eli, 104 Park, JaoHong, 168 Passive mutual funds, 133–134 Peacock tails, 122 Peles, Nadav, 50 Personal investing mission statement, 105–106, 193–195 Persuasion (Cialdini), 120 Persuasion, power of, 85–86 Persuasion bias, 84 Philippon, Thomas, 107, 146 Pickrell, Jacqueline, 26 Pigeons, superstitious, Pocheptsova, Anastasiya, 209 Polarization, group, 103–104, 168–169 Political forecasts, 51 Politicians, United Kingdom, 106–107 Pope, Devin, 45–46 Portfolio framing, 109–110 Portfolios, frequency of checking, 60–61 Portfolio Theory, 165–166 Price discovery, 135 Primacy effect, 21–22 Priming, 29–31, 35 Principle of fallibility, 81 Professional bias, 131–154 altruism, 141–142 anchoring, 147 backfill bias, 132 CEO compensation, 146, 148 confirmation bias, 139 corruption hypothesis, 150 dark pools, 135 earnings forecasting, 136, 137–138 easy data bias, 132 fiduciary duty, 152 forecasting, 136–140 gender differences in investing, 140–141, 143 herding, 139 idiosyncratic risk, 143 initial public offerings, 149–150 instant history bias, 132 losses, 150–151 masculinity, 140 mergers and acquisitions, 147 narratives, 153 overconfidence, 151 overoptimism, 138–140 price discovery, 135 INDEX regulation, professional, 151–152 risk-taking behavior, 140, 141–143 seersucker illusion, 139 share buybacks, 148–149 share options, 144–145, 146, 148 survivorship bias, 132 Texan Sharpshooter Effect, 153 trading costs, 150–151 winner’s curse, 150 women as investors, 140–141, 143 Pronin, Emily, 3–4, 39 Pronovost, Peter, 195 Psychophysical numbing, 57–58 Quantitative models, 144–145 Rabin, Matthew, 125 Radzevick, Joseph, 52 Rainy day fund, 190 Randi, James, 139 Random Walk Down Wall Street, A (Malkeil), 132 Rao, Akshay, 121 Rasmussen, Louise, 177 Rau, Raghavendra, 72 Reasoning, motivated, 101–102 Recency effect, 21–25, 162 Reciprocity, 118–119 Reflexivity, 79–82, 115, 175–176 Regression to the mean, 162–163, 170, 205 Regret, 55–56 Regulation, professional, 151–152 Reinforcement, 6–8 Reinhart, Carmen, 214 Reports, annual, 159–160 Representative heuristic, 31–32, 78–79 Resilience, 64 Resource depletion, 59, 62, 209 Results, tracking, 173, 176, 218–219, 224 Reviews, scheduling, 197–198 Risk, 18–19, 143, 166 Risk-taking behavior, 140, 141–143 Risky shifts, 103 Ritter, Jay, 149, 150 Rodin, Judith, 14 Rogoff, Kenneth, 214 Rosenthal, Norman, 86 Ross, Lee, 44 Roussanov, Nikolai, 143 Ruenzi, Stefan, 140 237 Index Rule of Seven, 187–188, 200 Rumsfeld, Donald, 12 Russo, J Edward, 173 SAD (Seasonally Affective Disorder), 87–88 Sales people, 16 Salience: about, 18–19 anchoring and, 48 availability and, 19–21 mass media attention and, 18–19, 77 noise traders and, 79 overcoming, 202 Sanghani, Jay, 140 Sapra, Steven, 142 Satisficing, 181–182 Save More Tomorrow scheme, 61 Savor, Pavel, 143 Scammers, 85–86 Schneider, Lukas, 132 Schwartz, Barry, 212 Schwarz, Norbert, 73 Schweitzer, Maurice, 45–46 Seasonal effects, 86–89 Seasonally Affective Disorder (SAD), 87–88 Seersucker illusion, 139 Self, future, 125 Self-control, 5–6, 191, 211 Self-enhancing transmission bias, 123–124 Self-esteem, 49 Self-fulfilling prophecy, 75–76, 81, 112 Self-image and self-worth, 37–66 affect heuristic, 56–58 anchoring, 46–48 anecdotal evidence, 58 availability, 48 Babe Ruth effect, 54 backfire effect, 49 beauty effect, 44 Black Swans, 54–55 blind spot bias, 39–40 checklists, 63 de Bondt-Thaler hypothesis, 61 December effect, 59 deferral to authority, 39–40, 44, 51–52 depressive realism effect, 43 disaster myopia, 54–55 disposition effect, 39–40, 44–46 emotion, 52–53, 56–58 exceptions, 63–64 failures, 62–63 forecasting, 51 fundamental attribution error, 45 hindsight bias, 50–51, 54 interpretations, 63 introspection illusion, 37–38, 39 loss aversion, 45–46 mental accounting, 55–56 mindfulness/mindlessness, 59, 62–64 moral accounting, 55 nudge theory, 61–62 observer bias, 54 overconfidence, 40–41, 43–44, 52 overoptimism, 40–44 over precision, 52 psychophysical numbing, 57–58 regret, 55–56 resilience, 64 resource depletion, 59, 62 salience, 48 self-esteem, 49 self-serving bias, 38, 39, 48–49, 159–160, 180–181 Self-serving bias, 38, 39, 48–49, 159–160, 180–181 Sensory finance, 1–33 anecdotal evidence, 19 attention, 27–28 availability, 19–25, 31–32 Barnum effect, 10–12 base rate neglect, 31–32 blind spot bias, 1–4 checklists, 28 conjunction fallacy, 29–30 dread risk, 18–19 false memory syndrome, 26 financial memory syndrome, 25–27 forecasting, 11–12, 17 frequencies, observed, 5, 31 gambler’s fallacy, 22–23 herding, 16–18 hot-hands effect, 23–25 ideomotor effect, 30 illusion of control, 13–15 illusory pattern recognition, 4–8, 10–12, 24 information overload, 26–27, 28 Linda problem, 29–30, 31–32 mass media, 18–19 Müller-Lyer illusion, 1–3 238 Sensory finance (continued) primacy effect, 21–22 priming, 29–31, 35 recency effect, 21–25 reinforcement, 6–8 representative heuristic, 31–32 salience, 18–21 self-control, 5–6 serial position effect, 21–23 Super Bowl effect, 9–10 superstitions, 6–8, 13 3D perception, 2–3 uncertainty, 12–13, 15–19 visual illusions, 1–3, 4–5 Wall Street Crash (1929), 20, 35 Serial position effect, 21–23 Serotonin, 141 Seru, Amit, 82–83 Seven, Rule of, 187–188, 200 Share buybacks, 148–149 Share options, 144–145, 146, 148 Share price movements, 121 Sharot, Tali, 139, 218–219 Sharpe, William, 133 Sharpshooter Effect, 153, 189, 201, 204, 223 Shefrin, Hersh, 17, 45, 111, 112, 138 Shifts, risky, 103 Shiller, Robert, 114, 174 Shoemaker, Paul, 173 Shorting stocks, 163–165 Shumway, Tyler, 82–83 Sieck, Winston, 177 Signals, 120–123 Simon, David, 123–124 Simon, Herb, 181–182 Situational finance, 69–95 accruals, 89–90, 91, 205 Adaptive Markets Hypothesis, 80, 90 anomalies, 89–92, 177 availability, 79 Babe Ruth effect, 54, 81 beauty premium, 70–71 butterfly effect, 80, 137 butter production, Bangladeshi, 91 complementarities, 75–76 composition, fallacy of, 92–93 contrast principle, 85 conversational bias, 83–84 crowds, wisdom of, 78–79 disposition effect, 82–83 INDEX economic reflexivity, 81–82 experience, 82–83 fallibility, principle of, 81 familiarity, 73–74 fluency, 73–74 Halloween effect, 88 halo effect, 71–73, 202 herding, 74–76, 78 January effect, 87, 88 mass media, 18–19, 77, 168–169 Moses Illusion, 73–74 narratives, 76–77, 153, 202, 223 noise traders, 78–79, 90–91 persuasion, power of, 85–86 persuasion bias, 84 reflexivity, 79–82, 115, 175–176 representative heuristic, 31–32, 78–79 salience, 77, 79 seasonal effects, 86–89 self-fulfilling prophecy, 75–76, 81 Super Bowl effect, 9–10, 91 technical analysis, 89–90 volatility, 75, 174–175 Skepticism, 189–190 Skiles, Jeff, 28 Skinner, B.F., Sloan, Richard, 89–90 Slovic, Paul, 57–58 Smith, Jennifer, 177 Social finance, 99–127 adverse selection, 120 affect heuristic, 101–102 asymmetry, information, 120, 121 backfire effect, 102 beauty contest investing, 117, 123 behavioral portfolios, 110–112 biases, overcoming, 202 bystander effect, 124–125 conformity test, 99–100 deceit, 118, 119–120 Efficient Markets Hypothesis, 111 embeddedness, 114–116 fairness, 118–119 framing, 108–110, 125 future self, 125 gaming the system, 106–108 group conformity, 99–100, 101 group polarization, 103–104 groupthink, 100–101 incentives, 105, 107 239 Index information asymmetry, 120, 121 lottery-insurance behavior, 110–112 lying, 118, 119–120 market failure, 120 memes, 113–114 mental accounting, 110 mind, theory of, 116–118 moral disengagement, 107–108 motivated reasoning, 101–102 Mutually Assured Delusion principle, 101 personal investing mission statement, 105–106 reciprocity, 118–119 reflexivity, 115 self-enhancing transmission bias, 123–124 self-fulfilling prophecy, 112 social identity, 104–105 stock market bubble formation model, 103–104 stock price movements, 121 trust, 118–120 used car market, 120 Social identity, 104–105 Social media, 90–92 Social networks, 123–124 Söderlind, Paul, 137 Song, Hyunjin, 73 Soros, George, 81–82 S&P 500 stocks, 133 Space Shuttle Challenger, 100–101, 202–203 Space Shuttle Columbia, 101 Spinoza, Baruch, 102 Spitzer, Elliott, 131 Stapel, Diederick, 145 Stark, David, 115 Statman, Meir, 45, 59, 110, 111, 112, 166, 178 Staunton, Mike, 216 Staw, Barry, 177 Steinmentz, Julia, 44 Stewart, Martha, 58–59 Stigler, George, 122 Stock buybacks, 148–149 Stock dividends, 112–113 Stock market bubble formation model, 103–104 Stock market participation, 20, 35 Stock options, 144–145, 146, 148 Stock price movements, 121 Stocks, shorting, 163–165 Stock tips, 42 Stoffman, Noah, 82–83 Stoner, James Arthur Finch, 103 Storytelling, 76–77, 153, 202, 223 Stracca, Livio, 216 Strahilevtz, Michal, 56 Subrahmanyam, Avanidhar, 49 Sullenberger, Chesley, 28 Summary review forms, 203–204 Sunder, Shyam, 112 Sunk cost fallacy, 177, 178 Sunstein, Cass, 61, 84, 103 Super Bowl effect, 9–10, 91 Superstitions, 6–8, 13, 202 Surowiecki, James, 78 Survivorship bias, 132 Svenson, Ola, 39, 48–49 Talib, Nassim Nicholas, 54 Teachable moments, 213 Technical analysis, 89–90 Temptation, resisting, 211 Tetlock, Philip, 51 Texan Sharpshooter Effect, 153, 189, 201, 204, 223 Thaler, Richard, 61, 138, 162 Thatcher, Margaret, 99 Theory of mind, 116–118 Thinking, superstitious, 6–8, 13, 202 Thorndike, Edward, 71 3D perception, 2–3 Tikkanen, Henrikki, 178–179 Time, taking, 15–16 Tip sheets, 42 Titanic effect, 175–176 Titman, Sheridan, 161 Tools, limitations of, 188–189 Tracking results, 173, 176, 218–219, 224 Trading, automated, 89, 93–94, 134–135, 174 Trading costs, 150–151, 224–225 Traffic safety, 13, 20 Trust, 118–120, 190–191 Tversky, Amos, 29, 44, 109 Twitter, 90–91 240 Unbelieving, 102 Uncertainty: about, 12–13 herding and, 16–18 living with, 174–175 salience and, 18–19 time constraints and, 15–16 United Kingdom politicians, 106–107 Unsystematic risk, 166 Updating adaptively, 200–201 Used car market, 120 Utkas, Steven, 103 Vaccination, 58 Validity, ecological, 182 Value, expected, 171–172 Vayanos, Dimitri, 84 Visual illusions, 1–3, 4–5 Vohs, Kathleen, 59 Volatility, 75, 174–175 Wall Street Crash (1929), 20, 35 Wang, Kevin, 163 INDEX Wason Rule Discovery Test, 167–168 Weather forecasting, 136–137, 173 Weber, Elke, 76 Weber, Martin, 8, 41 Weick, Catherine, 62 Welch, Ivo, 137 Whitson, Jennifer, 5–6 Williams, Kipling, 77 Willis, Lauren, 213 Wilson, M Scott, 161 Wilson, Timothy, 71–72 Winner’s curse, 150 Wisdom of crowds, 78–79 Wiseman, Richard, 88 Women as investors, 140–141, 143 Zahavi, Amotz, 122 Zajonc, Robert, 73 Zak, Paul, 142 Zeng, Xiao-Jun, 90–91 Zhu, Ning, 78, 148 Zweibel, Peter, 84 ... our customers’ professional and personal knowledge and understanding Investingg Psychology The Effects of Behavioral Finance on Investment Choice and Bias TIM RICHARDS Creator of the Psy-Fi Blog... own preconceptions, rather than theorizing on the basis of the data We’ll see patterns where none really exist, we’ll extrapolate on the basis of these illusory patterns, and we’ll then wonder... of Congress Cataloging-in-Publication Data: Richards, Tim, 196 1Investing psychology : the effects of behavioral fi nance on investment choice and bias / Tim Richards pages cm.—(Wiley fi nance