Koppel, Investing and the Irrational Mind

Robert Koppel’s Investing and the Irrational Mind: Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss (McGraw-Hill, 2011) is not a groundbreaking book, but it’s a darned good read. An engaging, well-crafted page turner which I finished in one sitting. Koppel interweaves findings from behavioral finance and neurology as well as insights from top traders to distinguish between expert/winning traders and novice/losing traders and to hint at how to join the ranks of the former.

In lieu of an “aerial” review of this book, I’m going to share a few points that I found particularly intriguing. I’m sure they reflect my somewhat idiosyncratic interests; others would most likely come away with an entirely different list. There is certainly a lot to choose from.

First, a scary finding from the field of neuroeconomics: that “after two repetitions of a stimulus, the brain automatically expects a third.” Of the many potentially damaging implications Koppel highlights one: “It is no wonder that after two profitable trades, we take it for granted that the next investment will be a sure winner.” (p. 89)

Second, a new word (at least for me): “Pareidolia is a psychological phenomenon involving a vague image or sound that is perceived as being significant. Familiar examples include seeing images of animals in clouds, seeing the man in the moon, and hearing hidden messages on records. It can also involve the subjective perception of instructions embedded in price charts when no such information is really there.” (p. 149

Third, writing about the illusion of control Koppel reports that this illusion “has been observed in games of chance, such as shooting craps, where players tend to throw harder for high numbers and softer for low numbers.” The illusion of control is detrimental to trading profits. For this reason, Koppel recalls, “It used to be a rule of thumb among trading executives, when they were looking to hire proprietary traders, to seek out individuals with successful histories in music, tennis, golf, or basketball. In general, these individuals were trained to think in subtleties, allowing themselves to let go and move with the flow. The need for control usually would not intrude on their performance. As a group, they were unlike former hockey players or football stars, who ached for control. Taking the bull by its horns, they were determined to fight on, no matter what the obstacle.” (p. 165)

Fourth, in a section entitled “Sometimes You Really Should Just Do It,” the author draws on the work of Daniel Gilbert, who studied the performance of golfers. In one study “subjects practiced putting golf balls, and got better as they continued to play. Their game play kept getting better, that is, until they were offered a cash reward for the next shot, and which point their performance fell sharply, as though off of a cliff.” Why the precipitous decline in performance? Part of the reason is that “we pay close attention to what we’re doing when what we’re doing matters, and though close attention is helpful when our task is novel or complex, it is positively destructive when our task is simple and well practiced.” (p. 211)

Finally, Koppel reports on a paper entitled “Exploring the Nature of Trader Intuition,” published in the Swiss Finance Institute’s research paper series and available for download at, among other places, the Social Science Research Network. It suggests that trading success is more a function of being able to read the minds of others (specifically, the ability to attribute to others mental states different from one’s own, an ability known as Theory of Mind [ToM]) than of mathematical ability. Apparently “forthcoming research out of Europe suggests that we may even have certain neurons for interpreting ToM when we can see people and different types of neurons for when we don’t have ‘a visual’ on the person—for example, interpreting through symbols, as we do when we are watching markets and charts.” (p. 218) It seems that science is vindicating the insights of some of the early traders. I wrote a post some time back (Wyckoff on reading the mind of the market) that speaks to this point.

Koppel has done an excellent job of synthesizing a broad spectrum of literature on the ways (and the reasons) we trip ourselves up. He doesn’t have a remedy for all the psychological failings that hurt our bottom line, but he offers some guidelines and even more clues. I personally like clues. They spark our imagination and, as we track them down, may let us carve a more productive space from which to trade.