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Magical thinking

Magical thinking describes subjective speculation about how markets will act. It is difficult to know for sure how significant a role intuition about the likelihood that investments will do well or poorly plays in peoples? decisions to invest. We are trying to assess innermost thoughts about money and self worth which most people feel they do not have to explain or justify to anyone. However, we can label these patterns of thought as magical thinking. Most investors have occasional feelings or intuitions that certain trading actions will bring them luck even if they know logically the actions can have no effect on their fortunes. Playing a hunch just because it feels right seldom makes traders rich. Yet proof that it’s human nature to indulge in magical thinking abounds:

  1. It has been shown that people will place larger bets on a coin that has not yet been tossed than on a coin that has already been tossed, but the outcome of the toss has yet to be revealed.
  2. If asked how much money they would demand to part with a lottery ticket they already hold, most ticket holders give a figure over four times greater than if they themselves chose the lottery number on the ticket. Apparently, at some magical level people think that they can influence a coin that has not yet been tossed and influence the likelihood of winning the lottery by choosing the number.
  3. People are capable of thinking, at least on some intuitive level, If I buy a stock, then it will go up afterwards or If I buy a stock, then others will probably want to buy the stock, too, because they are like me or I have a hot hand lately; my luck is with me. Such magical thinking is likely, in a subtle way, to contribute to the overconfidence that may help the propagation of speculative bubbles.

How does the mind of a trader work?

MindpowerIn order to understand behavioral finance and crowd behavior on the capital market, first of all we need to understand the factors that influence the trader mindset. Traders are “misled” by many things. Let us put these factors in two main categories, depending simply on their source, external or internal.

The most important external factor is “everyone else”, the trading crowd, the general opinion. We form an opinion about the others. We believe them to be either smart or stupid, either right or wrong, then choose one of the two main psychological trading strategies: “go along to get along” or be a contrarian. Then we have other external factors like payoffs, scale, psychological and academic background, social structure, external advisory and resources. (more…)

A Simple Logic Question That Most Harvard Students Get Wrong

Havard students get near-perfect SAT scores. These are smart, smart kids. So they shouldn’t have trouble with a simple logic question, right?
Try the following puzzle:
A bat and ball cost $1.10.
The bat costs one dollar more than the ball.
How much does the ball cost?
Scroll down for the answer … (more…)