Delusion, 'Non-Bottom Callers' & The Afflictions of the Investor's Mind

"The ignorant mind, with its infinite afflictions, passions, and evils, is rooted in the three poisons.  Greed, anger, and delusion." ~ Bodhidharma

We certainly have observed a wide range of emotions in financial markets over the past several months and we have analyzed them at length here at TFP.  Today, we will not necessarily analyze emotion but the delusion of making attempts to accurately recognize emotion as it occurs, and thereby making the mistake of investing according to this delusion... 

It seems the currently favored pastime in the world of financial news punditry is "bottom calling."  There are two primary camps in this prediction game:  Those who say we are at (or near) a bottom for broad market stock prices and, as you would expect, those who say we are not at a bottom and prices will fall farther...

"Until a man has expressed his emotion, he does not yet know what emotion it is..." ~ R.G. Collingwood

What I find especially interesting to observe is not the foolishness of the bottom callers, but the foolishness of the non-bottom callers, if you will, who believe that they are being wise in saying we are not at a bottom.  They appear quite confident and proud in their self-professed virtues of patience, experience and foresight.  They believe that it is the bottom-callers who are acting as fools and it is they, the non-bottom callers, who are acting prudently.

The preferred basis for which the non-bottom callers refuse to call a bottom is their self-professed ability to recognize market sentiment (emotion) as it occurs, specifically in current market conditions, the absence of panic and capitulation -- the primary emotions present when stock market prices hit a cyclical bottom. 

This is where the delusion takes place... 

While it is historically evident that bear market bottoms have been marked by the emotions of panic and capitulation, the non-bottom-callers fail to realize that these emotions come in different shapes, sizes and forms in each unique market cycle.  Put simply, it is widely known what will occur and what emotions will accompany the occurrence but it is virtually unknown how and when the emotions will appear.  Furthermore, once the emotion occurs, it is already in the past; therefore, it is impossible to accurately "call a bottom" in real time, with the exception of happenstance.

"Those who have knowledge, don't predict.  Those who predict, don't have knowledge." ~ Lau tzu

I've read this quote from Lau-tzu many times and have not fully applied its meaning or quite appreciated its profundity until now:  There are those who are aware of their own ignorance and those who are not.  Those who are aware of their own ignorance, do not predict.  Those who predict, are not aware of their own ignorance..

To say that we are (or are not) at a market bottom, are both forms of prediction (and foolishness), which is precisely my point:  While an investor may know that the next market bottom, if it has not already occurred, will be marked by panic and capitulation, that same investor will not be able to recognize the emotions as such until after they have come and gone.

Perhaps the lesson we may derive from this analysis of delusion is that we should not fool ourselves into believing that, just because we are taking the opposing side of an opinion we believe to be foolish, that our side must be the wise one.  We should remember that it is quite possible that both sides of a prediction have equal potential to be incorrect and that we would be better off not taking either position but to be a passive observer.

Here are more examples of two-sided opinions where there are beliefs or ideas on both sides that may be equally as foolish as the other:

• The market has hit a bottom. -- OR -- The market has not hit a bottom.
• It's different this time. -- OR -- It's the same this time.
• Tomorrow it will rain. -- OR -- Tomorrow it will not rain.
• If this happens, I will be happy. -- OR -- If this happens, I will be unhappy.
• This will make me money. -- OR -- This will not make me money.
• Stocks are risky. -- OR -- Stocks are not risky.
• Debt is good. -- OR -- Debt is bad.

Can you think of others? 

If we simply admit (and submit) to the wisdom that there is much that we do not know, and be contented with the certainty of uncertainty, we may guide our decisions (or indecision) accordingly, and our lives will be the better for it...

Related Posts:

Bull vs. Bear vs. 'Right' 

Weekend Wisdom: The Certainty of Doubt

Comments

[Ari Koinuma]

The last section is a great illustration. Looking at those statements, I can see how I shouldn't align myself to either statement completely. For example, to say that debt is always bad can keep us from starting a business or solving urgent problems.

As always, life is a balancing act, and each moment is a new unknown. The best we can do is to stand on both our feet and be ready to roll with the punches.

ari

[The Financial Philosopher]

Ari:

Great points! There are no real absolutes in this world and we have little control, except over our own participation in (and reaction to) physical world events.

We should give attention to those things we can control and be indifferent to those we cannot and, yes, balance and moderation are imperitive to our physical and mental health...

Thanks for the comment...

Kent

[Jeremy]

Despite recognizing that uncertainty is a normal part of life over a year ago, I still struggle sometimes to remember this simple truth.

On the one hand, visions and planning are essential in giving some purpose and direction, but if uncertainty is normal, how can one become emotionally attached enough to lead not only oneself, but also others, on a particular vision?

From Dwight D. Eisenhower:
"Plans are worthless. Planning is essential."

[The Financial Philosopher]

Jeremy:

You are correct. Planning is essential because uncertainty is a certainty. This is why we must place the greatest amount of energy on the things in life that we can control, such as our actions and reactions, and the least amount of energy on things that we cannot control, such as the actions and reactions of others...

Being a passive observer has its merits but not in every aspect of life. Absolute passivity does not differ much from inertia...

Also, without vision, we are blind...

Yet, blindness has its advantages, too, but that's another post!

Thanks, Jeremy. It's great to hear from you...

Kent

[Steve SSK]

Very interesting site, thank you for your work. I agree, it is all about probabilitys in the market. It is all about supply and demand. Best, Steve, SSK

[The Financial Philosopher]

Steve:

I agree. Probabilities and supply and demand are factors of the bigger picture of the market environment. The greatest challenge for the investor, however, is that the perceptions and emotions of the investor herd, regardless of fundamentals or reality, are perhaps a larger presence and influence on stock prices, especially in short-term market extremes...

Thanks for the comment...

Cheers...

Kent

[Soullfire]

Interesting post. I would agree that those who take opposite positions with invalid data or assumptions have no advantage over each other with regard to predicting future outcomes. However, if one side is correctly utilizing the data that is available to make a determination based on probable outcomes, one side could definitely have an advantage over another. Take the rain/no rain example- if once sunny skies become dark with clouds and the distant sound of thunder can be heard. The side taking the position that it will rain the next day will have a probable advantage over the side that says it won't. The same can be said about calling a bottom or not- it depends on the quality of data each side is using to base their determination on.

[The Financial Philosopher]

Soullfire:

You make a good point, especially in your use of the phrase, "utilizing the data that is available to make a determination based on probable outcomes."

Similarly, the "data available" on the "probable outcome" of an investor timing the market is lower returns over the long-term than for the investor who did not time the market and kept a passive, buy and hold strategy.

Making a prediction is not harmful in itself. But taking definitive actions based upon the prediction and failing to understand the consequences of our decisions is quite harmful...

If someone predicts no rain tomorrow because it is sunny today or because the weather man says 0% chance of rain, I will still keep an umbrella in my car. Similarly, I will not likely change my plans based upon a forecast for rain, either...

I believe you may be interested in a similar post on consequences as outlined by "Pascal's Wager" titled, "Finding God in Behavioral Finance." Here's the link:

http://financialphilosopher.typepad.com/thefinancialphilosopher/2007/10/finding-god-in-.html

Thanks for the comment...

Kent

[Frank Farbenbloom]

Yehezkiel Dror, my Professor of Political Science at the Hebrew University, in '72 gave a lecture that has turned out to be one of the most influential of my life.

Under the topic of "Public Policy Making" he discussed the issue of committees making plans.

The essential idea is that at the same time as one adopts a plan of action one must also have an alternative plan.

This alternative must be made at the same time as the main plan rather than waiting for the original to fail and then being forced to come up with an alternative in an "emergency".

From it I developed the concept of "Plan You Failure".

Applying the idea to my daily life has served me well for the past 35 years.

Thank you for another stimulating post.

Frank Farbenbloom

[The Financial Philosopher]

Frank:

Thanks for sharing your valuable lesson! Personally, I do not ask myself the question, "What will I do if I fail?"

I will say, however, that I do not really create "plans," as plans are traditionally viewed. Instead, I seek to "enable opportunities," some of which are known and some of which have not materialized yet.

So, in that respect, I do have "alternative" options as your Professor once suggested. The only place my view and his view differs is that I do not consider any of the alternatives as "failures" if they do not succeed because even our mistakes are opportunities to grow.

As I have said here before, the mistake is the philosopher's greatest tool for growth.

Thanks again for sharing your thoughts and please do so again in the future...

Kent