“Whosoever be the individuals that compose it, however like or unlike be their make of
life, their occupations, their character, or their intelligence, the fact that they have been
transformed into a crowd puts them in possession of a sort of collective mind which
makes them feel, think and act in a manner quite different from that in which each
individual of them would feel, think and act were he in a state of isolation.”
Gustav Le Bon 1897
Chaos theory postulates that we can make accurate predictions in terms of probabilities
and this is certainly true of market behaviour. Although all investors think differently, in
the investment arena people change in crowds. In crowd’s investors, as a whole, react
to their emotions rather than their intellect, and it is these basic instincts that can be
predicted and controlled by those investors able to stand aside from the crown and think
in a rational manner.
Typically a bull market starts ina period of uncertainty or fear. As more buyers enter the
market, prices rise and confidence appears. As prices rise, the more greed and hope
that prices will continue upwards for the foreseeable future. After a period everyone
has bought, and there is no one left to push prices higher, a small number of investors
exit the market, fear emerges, and there is a mad scramble to exit the market. This
scenario to a greater or lesser degree occurs in all investment markets.
1. Human nature in investment markets on mass is constant and repetitive over
time.
2. Investors tend to be followers, not leaders, and this causes trends to develop.
3. Investors tend to generally exhibit the basic emotions of greed, fear and hope
when making investment decisions.
4. The more bullish or bearish the market becomes, the greater the probability of a
reversal.
Human nature has remained constant for thousands of years, and although all humans
think differently, the in uence of the crowd allows ut to predict market turning points
and market trends with a degree of accuracy. I have covered the predictability of man’s
investor behaviour in greater detail in my “Special Situations” essay, which should be
read in association with this work.
UNDERSTANDING OUR NATURE
“A man’s character is his fate”
Heralatus
What actually is man, why does he think and act in the way that he does? What is the
relationship between mind and body? What in uences his behaviour? Since the ancient
Greeks defined Psyche as the Goddess loved by Eros, philosophers have produced
numerous con icting theories of human nature.
In 1762 J.J. Rousseau wrote his famous test “Emile”, which introduced a revolutionary
theory of childhood and human nature that is still relevant today. Rousseau argued that
man’s nature was essentially good; however, his nature was in uenced and corrupted by
society. Rousseau believed that a child’s mind was “Tabula Rosa” or a clean slate when
the child was born, and it was at this stage that the child has the potential within itself
to develop almost unlimited talents. The clean slate has experiences and rules written
upon it as the child learns and develops. As a child moves from birth to adulthood, he
effectively becomes a re ection of his experiences.
Rousseau’s theory is very idealistic and perhaps naïve; however, he does pose two
very important questions. First, how much of human behaviour is learned and how
much is genetic? Secondly, how much in uence does society have upon us? There
are undoubtedly instincts and primary needs that we are born with, and no two infants
are exactly alike, i.e. children have different responses to stress. However, it is the
environment that is the major in uence on our behaviour. Children take on the attitudes,
behaviour and opinions of those around them. With investment there is no doubt that
all aspects of investment behaviour can be learned.
“It’s the psychosomatic form in which man experiences his estimate of the beneficial or
harmful relationships of some aspects of reality to himself.”
Definition of Emotion
As we have stated earlier, method and knowledge by themselves are simply not enough.
If there is one crucial factor that makes an investor a winner, it is emotional discipline,
which gives the will and ability to execute knowledge. In order to acquire it we need to
look at our desire and motivation, and how these two con icting emotions need to be
reconciled in order that we can trade successfully.
All of us, at certain times, lack motivation. We may desire a whole host of different
goals, yet we lack that spark of motivation to get us there. To fulfil our desires and
reach our goals, we need to channel our desire through positive motivation.
Positive motivation is needed to get us to our goals. Without it, all our knowledge and
desires are useless. Consider the area of weight loss. You can go into any bookshop
and you will see countless scientifically proven methods of losing weight. Yet out of
every 100 people who start a course, only 10 succeed in losing weight, and only 2 in 100
keep it off for more than a year. The success rate is less than futures trading! Ever seen
those step-by-step language courses - just follow the tapes and in no time at all you will
be speaking your desired language with uency. Now everyone can learn a language,
yet the success rate here is about the same as in the area of weight loss.
“People who deal with stress believe that an increase in the pain and strain must happen
before the pain will go away. Their approach to stress and life is similar to Nietzche’s
statement ‘whatever does not kill makes me stronger.”
Salvadore Madd
There are two fundamental emotions that stand in the way of positive motivation. The
two emotions are the need to avoid pain and the desire to achieve pleasure. In order of
importance, the need to avoid pain dominates. If our desires remain unfulfilled we will,
however, feel empty, depressed and dissatisfied. Our motivation to reach our goals is
continually undermined by con icting emotions.
To achieve our desires and feel fulfilled, we need to suffer some pain. It is the ability
to see this pain in a positive way that will help us reach and fulfil our desires and give
us happiness. In the case of the language course, it is working with boring repetitive
material; with the diet it is the pain of being deprived of food we crave. If you think of
the pain/pleasure relationship in trading, you should consider the fundamental rule of
trading: cut your losses and let your profits run and you will see why the majority of
investors find it so difficult.
Taking a loss, however small, is painful and ego de ating. It means an admission of
being wrong. Rather than take the loss, people hold on and hope that it will turn around
and become profitable, and therefore pleasurable. In the world of trading this very rarely
happens - the result is normally a bigger loss and greater pain. Similarly, when we see
a profit in the market, the pleasure we derive from this means that most investors take
it before it has the chance to turn around and cause pain. To be successful, it is clear
that one needs to be able to positively accept short-term pain to reach our ultimate
goals and desires.
“Let me tell you the secret that has led me to my goal: my strength lies solely in my
tenacity.”
L. Pasteur
To achieve positive motivation you need to set clear, long-term goals and motivate
yourself towards them. An acceptance of short-term pain, therefore, is inevitable. If
you make a complete honest commitment on what you want from life, why you want it,
and how you intend to fulfil your desires and goals, this personal honesty will release
you from the pain/pleasure paradox that most investors suffer from
