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Welcome back to Mind Over Money. I'm Kevin Cook, your field guide and story teller for the fascinating arena of behavioral economics.
For our first episode of 2018, I can't imagine a better way to start than with a story about the progenitors of our favorite playing field, the collision of markets and psychology.
My title comes from a book I saw over the holidays as I was passing a store in the train station in Chicago and the title caught my eye.
The Undoing Project has a big pencil eraser on the cover of the paperback. And some guy named Michael Lewis is the author. I picked it up and the subtitle read "A Friendship That Changed Our Minds."
It was about Daniel Kahneman and Amos Tversky.
I didn't have time to look at it for more than a few seconds before my train would be off without me.
But I thought about that title and where Lewis might be going...
Was he implying that Kahneman and Tversky had created ideas, research, and tools to undo centuries, if not millennia, of faulty, irrational, bias-laden thinking and decision-making?
Because if that's what he meant, that title, The Undoing Project, was a strange combination of brilliance and simplicity, at once sweeping and subdued, almost mechanical.
Unfortunately, I stopped thinking about it between Christmas and New Years in the whirlwind of family gatherings, endless meals, and playing outside on the pond with my kids who were barely affected by the sub-zero deep freeze of southern Wisconsin.
Kahneman and Tversky did "change our minds about our minds" in ways I've been writing on for over ten years, ever since I was fortunate enough to be introduced to their work.
The two revealed, with repeatable experiments, that things are not always what they seem.
Not because of a grand right or left-wing conspiracy. But because our perceptions, biases, and blindspots lead us astray.
They lead us in endless loops of unexamined experience, assumptions, emotions, unconscious beliefs, prejudice, and habits, and thoughts that comfort, or not.
Together, the work of Kahneman and Tversky and many other researchers they taught and inspired, revealed how we tend to believe that we are rational, productive creatures most of the time – while experimental tests and objective analysis of our behavior patterns show consistent evidence to the contrary.
When I first started using their work to understand my own trading and investing, I combined it with what neuroscientists were teaching us about our brains' structures and functions. For simplicity's sake, I said that while the brain scientist explains our behavior from the inside-out, the behavioral researcher reveals what might be going on from the outside-in.
Either way, the logical conclusion was the same for me: In terms of both human neural evolution and social-cultural learning, “our brains were not made to trade.”
In short, Kahneman and Tversky helped the world understand with evidence what Mark Twain is allegedly to have offered with his scathing wit: “It ain’t what you don't know that gets you into trouble. It’s what you know for sure that just ain’t so.”
As an aside, that quote was used in the beginning of the film version of Michael Lewis's book The Big Short and there is debate about whether Twain actually said it. According to Alex Shephard writing in the New Republic two years ago, "The closest [Twain] came is 'Faith is believing what you know ain’t so,' which appears in Pudd’nhead Wilson’s New Calendar."
And while no scholar can seem to nail down who modified this much simpler version that Twain is proven to have quipped, we know what he meant. And he nailed it.
A Big Week for Artificial Thinking
In the publisher's description of The Undoing Project on Amazon, we find this line...
Kahneman and Tversky are more responsible than anybody for the powerful trend to mistrust human intuition and defer to algorithms.
This of course gets me thinking about decision-making technology like artificial intelligence (AI) applications showing up in everything from games and cars to medical research and investing.
And we should get some exciting news on these fronts all next week as the Consumer Electronics Show (CES) gets started in Las Vegas on Sunday January 7. NVIDIA (NVDA - Free Report) CEO Jensen Huang is expected to kick off the event with details on their latest efforts in the automotive space.
And I know I'll be watching for the latest innovations from Microsoft (MSFT - Free Report) , Alphabet (GOOGL - Free Report) , Baidu (BIDU - Free Report) and Apple in (AAPL - Free Report) in augmented reality (AR) and virtual reality (VR) as I believe these areas have huge applications to management, education, training and design in nearly every industry.
While AI will become embedded in almost all software applications and sort of “disappear” into the background of everyday business and consumer experiences, AR and VR will be active ways to engage advanced technologies.
A Fantastic, Necessary Achievement by Lewis
Now, back to The Undoing Project, I'm actually quite embarrassed that I didn't notice the book before, since it was published in December a year ago by W.W. Norton.
I finally went and bought the paperback about an hour ago -- which came out recently, and there's a unique twist there too. More on that coming up. So I still can't tell you how Lewis intends the title, or if it came from something Danny or Amos said.
But yesterday, I found something equally exciting: a review of the book by a man who is inextricably intertwined in this entire tale. Not only was he a student and friend of Daniel Kahneman, he also inspired Lewis to write The Undoing Project.
In The New Yorker magazine on December 7, 2016 appeared this article: "The Two Friends Who Changed How We Think About How We Think," by Cass R. Sunstein and Richard Thaler.
In that article, Sunstein and Thaler, Kahneman's student and friend, tell the story of their first review of a Michael Lewis book, Moneyball, and how they informed the writer, to his surprise, that his subject was really all about behavioral economics.
This eventually led to Lewis taking a greater interest in the work of Tversky and Kahneman. But a book was the farthest thing from his mind.
In the podcast, I read a few paragraphs from that Thaler and Sunstein review which explains, in part, how Michael Lewis stumbled his way into writing The Undoing Project.
I also share a special author's note from Lewis in the new paperback edition in which he explains how he almost didn't write the book. Or maybe it's better to say how he resisted writing it for so many years, even as he immersed himself in the stories and work of the partnership that created a new field of economics.
Getting Systematic to Overcome Biases and Blindspots
Finally, if one of the greatest contributions of Amos and Danny was to show us the ways in which the human mind erred, almost systematically, when forced to make decisions and judgements under uncertainty and risk, then one of my contributions might be a small footnote to their work.
I implemented the following idea in the training of active investors and traders to reduce their systematic errors, and the subsequent emotional confusion that could often lead to really big blunders:
Probability-based decision-making systems and rules that could prevent and overcome such persistent errors and blunders.
In essence, the antidote for systematic errors is systematic, rules-based decision processes.
Now, I'm not the first successful investor or trader to develop systems, rules, and decision-making algorithms to enforce discipline, consistency, and risk control.
But I did do something unique in terms of trader education by…
(1) creating a logical imperative argument based on neuroscience and behavioral economics that I called "Your Brain Wasn't Made to Trade"
(2) developing a sequence of training and simulation to uncover bad trading habits, and finally
(3) teaching probability-based action-rules as the antidote to undisciplined trading.
There is no Nobel prize waiting for my training ideas. There might not be any need for them either as the markets are dominated by automated trading programs and algorithms.
But here's one simple behavioral economics idea you might find very useful – presented in a practical video and article -- and you can apply it right away to either better your trading, teach your kids probability and statistics, or just annoy your friends who use technical analysis religiously...
Image: Bigstock
What's The Undoing Project All About?
Welcome back to Mind Over Money. I'm Kevin Cook, your field guide and story teller for the fascinating arena of behavioral economics.
For our first episode of 2018, I can't imagine a better way to start than with a story about the progenitors of our favorite playing field, the collision of markets and psychology.
My title comes from a book I saw over the holidays as I was passing a store in the train station in Chicago and the title caught my eye.
The Undoing Project has a big pencil eraser on the cover of the paperback. And some guy named Michael Lewis is the author. I picked it up and the subtitle read "A Friendship That Changed Our Minds."
It was about Daniel Kahneman and Amos Tversky.
I didn't have time to look at it for more than a few seconds before my train would be off without me.
But I thought about that title and where Lewis might be going...
Was he implying that Kahneman and Tversky had created ideas, research, and tools to undo centuries, if not millennia, of faulty, irrational, bias-laden thinking and decision-making?
Because if that's what he meant, that title, The Undoing Project, was a strange combination of brilliance and simplicity, at once sweeping and subdued, almost mechanical.
Unfortunately, I stopped thinking about it between Christmas and New Years in the whirlwind of family gatherings, endless meals, and playing outside on the pond with my kids who were barely affected by the sub-zero deep freeze of southern Wisconsin.
Kahneman and Tversky did "change our minds about our minds" in ways I've been writing on for over ten years, ever since I was fortunate enough to be introduced to their work.
The two revealed, with repeatable experiments, that things are not always what they seem.
Not because of a grand right or left-wing conspiracy. But because our perceptions, biases, and blindspots lead us astray.
They lead us in endless loops of unexamined experience, assumptions, emotions, unconscious beliefs, prejudice, and habits, and thoughts that comfort, or not.
Together, the work of Kahneman and Tversky and many other researchers they taught and inspired, revealed how we tend to believe that we are rational, productive creatures most of the time – while experimental tests and objective analysis of our behavior patterns show consistent evidence to the contrary.
When I first started using their work to understand my own trading and investing, I combined it with what neuroscientists were teaching us about our brains' structures and functions. For simplicity's sake, I said that while the brain scientist explains our behavior from the inside-out, the behavioral researcher reveals what might be going on from the outside-in.
Either way, the logical conclusion was the same for me: In terms of both human neural evolution and social-cultural learning, “our brains were not made to trade.”
In short, Kahneman and Tversky helped the world understand with evidence what Mark Twain is allegedly to have offered with his scathing wit: “It ain’t what you don't know that gets you into trouble. It’s what you know for sure that just ain’t so.”
As an aside, that quote was used in the beginning of the film version of Michael Lewis's book The Big Short and there is debate about whether Twain actually said it. According to Alex Shephard writing in the New Republic two years ago, "The closest [Twain] came is 'Faith is believing what you know ain’t so,' which appears in Pudd’nhead Wilson’s New Calendar."
And while no scholar can seem to nail down who modified this much simpler version that Twain is proven to have quipped, we know what he meant. And he nailed it.
A Big Week for Artificial Thinking
In the publisher's description of The Undoing Project on Amazon, we find this line...
Kahneman and Tversky are more responsible than anybody for the powerful trend to mistrust human intuition and defer to algorithms.
This of course gets me thinking about decision-making technology like artificial intelligence (AI) applications showing up in everything from games and cars to medical research and investing.
And we should get some exciting news on these fronts all next week as the Consumer Electronics Show (CES) gets started in Las Vegas on Sunday January 7. NVIDIA (NVDA - Free Report) CEO Jensen Huang is expected to kick off the event with details on their latest efforts in the automotive space.
And I know I'll be watching for the latest innovations from Microsoft (MSFT - Free Report) , Alphabet (GOOGL - Free Report) , Baidu (BIDU - Free Report) and Apple in (AAPL - Free Report) in augmented reality (AR) and virtual reality (VR) as I believe these areas have huge applications to management, education, training and design in nearly every industry.
While AI will become embedded in almost all software applications and sort of “disappear” into the background of everyday business and consumer experiences, AR and VR will be active ways to engage advanced technologies.
A Fantastic, Necessary Achievement by Lewis
Now, back to The Undoing Project, I'm actually quite embarrassed that I didn't notice the book before, since it was published in December a year ago by W.W. Norton.
I finally went and bought the paperback about an hour ago -- which came out recently, and there's a unique twist there too. More on that coming up. So I still can't tell you how Lewis intends the title, or if it came from something Danny or Amos said.
But yesterday, I found something equally exciting: a review of the book by a man who is inextricably intertwined in this entire tale. Not only was he a student and friend of Daniel Kahneman, he also inspired Lewis to write The Undoing Project.
In The New Yorker magazine on December 7, 2016 appeared this article: "The Two Friends Who Changed How We Think About How We Think," by Cass R. Sunstein and Richard Thaler.
In that article, Sunstein and Thaler, Kahneman's student and friend, tell the story of their first review of a Michael Lewis book, Moneyball, and how they informed the writer, to his surprise, that his subject was really all about behavioral economics.
This eventually led to Lewis taking a greater interest in the work of Tversky and Kahneman. But a book was the farthest thing from his mind.
In the podcast, I read a few paragraphs from that Thaler and Sunstein review which explains, in part, how Michael Lewis stumbled his way into writing The Undoing Project.
I also share a special author's note from Lewis in the new paperback edition in which he explains how he almost didn't write the book. Or maybe it's better to say how he resisted writing it for so many years, even as he immersed himself in the stories and work of the partnership that created a new field of economics.
Getting Systematic to Overcome Biases and Blindspots
Finally, if one of the greatest contributions of Amos and Danny was to show us the ways in which the human mind erred, almost systematically, when forced to make decisions and judgements under uncertainty and risk, then one of my contributions might be a small footnote to their work.
I implemented the following idea in the training of active investors and traders to reduce their systematic errors, and the subsequent emotional confusion that could often lead to really big blunders:
Probability-based decision-making systems and rules that could prevent and overcome such persistent errors and blunders.
In essence, the antidote for systematic errors is systematic, rules-based decision processes.
Now, I'm not the first successful investor or trader to develop systems, rules, and decision-making algorithms to enforce discipline, consistency, and risk control.
But I did do something unique in terms of trader education by…
(1) creating a logical imperative argument based on neuroscience and behavioral economics that I called "Your Brain Wasn't Made to Trade"
(2) developing a sequence of training and simulation to uncover bad trading habits, and finally
(3) teaching probability-based action-rules as the antidote to undisciplined trading.
There is no Nobel prize waiting for my training ideas. There might not be any need for them either as the markets are dominated by automated trading programs and algorithms.
But here's one simple behavioral economics idea you might find very useful – presented in a practical video and article -- and you can apply it right away to either better your trading, teach your kids probability and statistics, or just annoy your friends who use technical analysis religiously...
Trend Lines Are Mathematically Absurd
Disclosure: I hold shares of NVDA, AAPL, and BIDU for the Zacks TAZR Trader portfolio.
Kevin Cook is a Senior Stock Strategist at Zacks Investment Research where he runs the TAZR Trader service.