Posted by Robert on May 21, 2012
B. F. Skinner was a behaviourist who, in the 1960s, experimented with pigeons to learned about behaviour and conditioned responses. In one of my favourite experiments, he put the pigeons in a cage where they received food at random intervals. Over time, the pigeons developed complex routines in anticipation of receiving the food. Skinner compared these behaviours to superstitions. He said: “The experiment might be said to demonstrate a sort of superstition. The bird behaves as if there were a causal relation between its behavior and the presentation of food, although such a relation is lacking. There are many analogies in human behavior. Rituals for changing one’s fortune at cards are good examples. A few accidental connections between a ritual and favorable consequences suffice to set up and maintain the behavior in spite of many unreinforced instances.”
Could the same thing happen with the stock market? I think it does. An individual stock sometimes seems to have a personality. For example, it may go up and down in a specific range, and it might move at a steady rhythm. An investor could then buy low and sell high repeatedly… until the stock suddenly moves outside its range. Or the market as a whole may appear to move in cycles. In fact, there’s a market saying: “sell in May and go away.” It implies that the best market returns are between November and May, while the summer months are usually dull and September and October are often the worst months in the market. Is that true? Research has been done that finds it sometimes holds true; not often enough to make much money, so it’s a gamble.
“Past performance is no guarantee of future returns.” Unfortunately, past performance is all we have available. It’s possible to look at historical returns long enough to find a pattern in any market or stock. But the question remains whether the pattern is an indicator of a predictable future outcome, or whether it’s just the result of random returns. Andrew Lo famously said: “If one tortures a data set long enough, it will confess to anything.” Is that another form of superstition?
As I invest in the market, I get some right and I get some wrong. Recently, I’ve gotten EnerPlus very wrong. At least, that’s how it feels. At the same time, the entire TSX (and many other markets) are falling. So maybe it’s not a bad choice, maybe it’s just a bad time. My point is that the “feedback” that I receive from the market is unsteady and unclear. It’s almost impossible to evaluate my judgement based on whether or not my stock increases in value over the short-term. And over the longer term, it’s easy to forget how I made my decision in the first place, so the feedback really doesn’t reinforce my decision-making.
How can you tell whether your investment choices were right or wrong? How will you know if you need to change your investment strategy?