Psychological traps

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[via Capital Ideas Online] Dr. Richard Geist in his book Investor Therapy writes about the psychological traps that investors are prone to when facing negative news.

The Primacy of Negative News. It is a psychological axiom that human beings pay much more attention to negative than positive news. We seem to share a perverse but ingrained fascination with suffering, loss, catastrophe, and the ills of others. Sometimes it is merely out of guilt, as when we stare at a handicapped person, not wanting to think "better you than me." Sometimes the fascination has its roots in complex feelings of jealousy, envy, and fear of loss. That's why media headlines emphasize disasters and often feature market commentators who are most fond of predicting gloom and doom. Our penchant for negative news, combined with our tendency to place the highest value on most recent information, leaves us vulnerable to undue emotion ­based pessimism. This phenomenon prevails not only for broad market corrections, but even more so for corrections in individual stocks.

Rumors and Gossip. Because we tend to perceive any correction as a crisis, we have a natural defense of retreating to herds for protection. Herd mentality, fostered by corrections, promotes rumors and inaccurate information. Even the most rational investor is subject to their influence if the messages are repeated often enough in disparate contexts. Those who read the Internet stock message boards can witness firsthand how inaccurate information becomes "truth" in a matter of minutes. Only those who perceive themselves as outsiders, individuals who don't quite fit in with the current system and have come to terms with that status, seem able to resist capitulating to the rumors and gossip fed on by the herd.

Scapegoating. Every correction seems marked by a psychological need to blame someone. Both the suddenness of its onset and the anxiety it engenders leave investors temporarily feeling like the small child who, while running into the kitchen, bumps into a table and is furious at either the table for being there or the parent who put it there: "My broker should have told me," or "The CEO knew this was going to happen," or "The analyst's timing was dead wrong," or "It was only a stock promotion." Psychological scapegoating absorbs time and energy that should be directed to understanding the fundamentals of our own stocks and the market's monetary, valuation, and psychological dynamics.

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