I’ve written before about how gut instincts and rapid reflexes – behavioral factors – can do you in as an otherwise sensible investor. The other day, I was reminded that, in other walks of life, those instincts aren’t such a bad idea. Like if you encounter a real, live rattlesnake.
I had been fishing with my good friend Mark on a small stream north of State College, Pa. Mark and I often go fishing early on Sundays, to beat the heat and have the creeks to ourselves. It was a glorious summer morn. The weather was unseasonably cool and dry. The sun was shining and the brook trout were biting. We had just finished for the day and were walking through a newly mowed field back to the car.
Then … SNAKE!!!
Next thing I knew, that snake was 10 feet away. I can’t even tell you how, but I had reacted instantly, leaping backward before my brain had even formed an image. Honestly, I didn’t even know I was capable of moving that fast. Mark was amazed as well.
Once I regained my senses, I was able to assess what had just happened. The snake was a big timber rattler, coiled right where I’d been a split second ago. Mark thought it was about 4–5 feet long. It was certainly the largest one I had ever seen face to face.
It was probably the sound of its warning-rattle that I’d reacted to with such nimble panic. That snake and I stared at each other for a second or two, both of our tails still shaking. And then, to my relief, it slithered to my left, back into the woods from whence it came.
Whew, I was lucky. Pushing that luck just a little, I looked at Mark as I swung my camera from around my back. Here’s the shot I took as Mr. Snake and I parted ways.
Once my heart stopped pounding, the encounter got me thinking about the importance of pattern recognition to our survival, and how my brain’s amygdala, or fear center, had so admirably put my legs into motion before that snake had time to strike. That kind of pattern recognition has served humans well through the millennia. Certain patterns like tiger stripes and snake rattles are clear danger signals … at least to those of our ancestors who managed to pass on their genes.
But, as Meir Statman wrote in “What Investors Really Want,” his book on behavioral finance, “Our ability to find real patterns is a mark of our intelligence, but our intelligence often backfires, as when we identify illusory patterns as real.”
In other words, not all patterns are real, and sometimes it’s a really bad idea to react as if they were. Financial patterns are a prime example. You don’t have to listen to the financial press for more than about 10 minutes to hear a talking head explain that “the charts” are indicating such and such, or that the recent trends in the price of whatever indicate a looming recession or a vibrant economy.
There are at least two problems with these sorts of “patterns.” First, the trends these gurus are pointing out may be actual patterns … or they may just be shadows in the proverbial grass. Behavioral finance again informs us that, due to our extra-sensitive snake-dodging instincts, we’re hardwired to frequently detect patterns where none actually exist. False alarms, if you will.
Second and more compellingly, there also is an extensive body of clear and compelling evidence that informs us: Even if there is some sort of financial or economic pattern or trend on the move, that doesn’t tell us how the capital markets will react to it, especially moving forward. Thus it’s essentially impossible to profitably trade on existing patterns, be they real or illusory. We’re all familiar with the financial adage: The past (or present) does not predict the future.
The moral of this tale of the rattlesnake tail? We human beings are often overconfident about the patterns we “see” in financial data, failing to realize how noisy that data can be. We’re better off saving pattern recognition for the important stuff, like real-life tigers and snakes, because in investing, pattern-chasing just may bite your portfolio.