of theStockMarket

ThePsychology
Eachushad comet) the concluslonthat sklll ln
Long belore the stock market.'crash"last october, Peter
In recenteventsto makehlm changehls mlnd.
lnvestmentrr a *vtn anda deluslon.He seesnothlng
to investmentbehaviour,he argues,it can be seenthat goodluck
By applylngsoclalpsychologlcaltheorles
brlngssuccess'
ratherthan Intelllgence
your savlngs),don't botherto analysethe market'lt can'tbe
r" ll you want to makea lortune(or safeguard
J6n". your best bet ls to be a rlsk-taktngnon-conformlst.
faclorslhat
What are the psychological
And how
investors?
individual
influence
does the cumulativebehaviouro{ lhese
lead to rises and falls (bull
inOiuia-Jit"
in
and bear) the stockmarket?
investor'
Beforewe lookat the indivitJual
for a momentwhy
iiii *onn consirJering
trade in ih stockmarketoccursal all'
lc"orOins to th El{bientMarketHypoitrelis fX6ane,1980),il the marketis efficientdhensharesarepricedaccurately'
i.e. all tradersagrsthat the pricecorrectlYrepresentsthe Potenlialvaluol
tne 6omianv.But if this weretru'then
no tiaO.iwouldensue.Obviouslytrade
thereforeeilher the
Ooes tafe,g*e;
market is n-otetfHent,or il is not perieived to be efficientby those in the
market.
h is differencesin perceptbnsof the
markel bv indivUualinvestorsthat prooriJ1i".ie. Thegbc of a security,is..a
ais.
of the'exPedatbns4
ii.sire
aareements of the analysts' I nus In
oider to undets{andwhy pdces$-9ng disinhibition. lnvestment involvdS risk,
'n|uen- risk poduces lensbn and this is tell as
we needto bok at psychological
siieis, somethirg most of us rvould
ces on lh investoror analYsl'
rather avoid. Avoidance ol tension is ac-

The conformltYhYPothasls
comolished bY inhibiting Ets lar as
The stock marktcan be consideredan posdiOte
'under risk-takingbehaviour.However,
certain contilions, this inhibition
"t-tio.or" situation.We are presnted
invsstmsntoP may itself be inhibited,thus allowing.the
withi massof competing
oortuniliesand we are notqurt.canaln rls(y behaviourlo occur:this is disinhibiwhat we shoulddo- Typbally'.ln snu- tion. Two @mmon examplesof this can
ationslike this, we bok aroundtq s9 be seen in driverswho'iump'red lQhts'
wnlt otner PeoPleare doing' (Asch' and oedestrianswho crossthe roaddesigsil Indeedil'is probablvilq9sslb]e pit"'tn" crossing signal being against
In com- [hem. Both Uenavioursinvolvesome risk
to mike invesimenl
iudgemenls
olete isolation,since the influencsol and thereforea degreeof disinhibition'
Srnersis nowfelt internationally'.When.a
Under what conditionsdoes disinhibilion
sharsor marketis rising'or lalllng'.I ls occur? The crucial iactor seems to be
thereforevery difficultfor the incllvldual the ptesenceof other people,particularly
to.behave
investorto r;istthe pressure
perceivedas beingof
In i{ thbse people arestatus.We are more
as thevbelieveothersarebhavlng'
higher
6r
similar
i"triibt @urseis that the share and likelyto 'iump' the traflic lights il.th.car
svn mors the market- willcontinueto iust-infr6nt does the sams, and thls ls
'en"n
rise,or lall.
tote likely if the car in front is a
bulls
do
Why
-Br.rithen why doesit stop?
Mercedes rather than a l'/orris Minor'
becomebears,andviceversa?
When waiting at the crcssingfor the signal lo cross w are constantlymonnonng

Thedlslnhlbltlonhpothls
the bhavbur of other pedestriansalso
A s@nd exPlanatbnbr stock market waiting to cross. lf a well dressedbusibehavicurirwolvesthe phenomenonol
'.f!t,'-ltp"

March 1988

ness-typeperson steps out againstlhe

signal, people will follow, but il a scrufly
tramp steps out, most people will stand
firm.
Thus the risksthat other people are willino to accepthave a direc{influenceon
th6 degreebf riskwe are preparedto tolerate. In most cases lhe risks that we
{ind acceptableincreasein the presence
of other people (Kogan & Wallach,
1967).The resultof this in stock market
"lollowing' behaviourcharterms is the
a
bull market,and lhe apparof
acteristic
ent increases in risk that investorsare
preparedto take.
Under these circumstancesthe average
gains and losses will only ever be
iroderate relative to the maiket indicators (FT indices,Dow Jones etc).The inveslors who will !o really well are those
people who do iot coriform to market
opinionand are able to tolerate,psycholog'rxlly and financially,a high degreeof
risk.
How bulls become bears
What happensto the indlvidualduring a
rising market,and how do psychological
chanoes eventually lead lo peaking of
the m-arketand its uhimatedecline?
As marketsstart to rise, feelings of security and poshive expectation are
oendrated. Volume of trade increases
ind more profils are made. All trade
however his its associated risk, and
therefore increasing volumes of trade
are accompanied bY a Perceivedincrease in risk. In the early stagesof a
bull market this perception ol risk is
probably subliminal,is easily tolerated
and mighteven be enioYed.
But as the market continuesto rise' so
the perceived level of risk slarls to
become less tolerable, perhaps slressful. One of the firsl @nsquencesof this
is rumour. lnveslors are uncomfortable,
but lhey are not sure why. After all, they
are in a rising market.When ws.experlence feelingsthat we canl explain' we 1
seek oul explanations,and il we are ,
frustrated in our search we will invent I
them. The resuh is rumour and counter- \
rumour: P/E ratios are too high' Northy'

\
S'-

The Psychologist,vcoa

STOCKMARKET
have accessto superiorinformationover
tor. Low risk-takerswill only ever be
moderatelysuccessful,lhey will only out- a prolongedperiod?Markettheory sugthrives in Periodsof perform the market by good luck. High gests not. Neverthelesssome people
iii?.
risk-takersare mor likelyto be success- appear to do better than average.How
uncnalnly'
can this be?
ful,
but they are also more liklyto fail.
in
The outcomeof this is grealer volaility
personality
To understandthis we need to look at
perlooking
at
risk
as
a
When
Increases
turn
In.
whtch
th rnarkel,
discriminatebetween the psychologicalfactors that are inproduces
we
should
trait,
tension,
which
risk,
of
""otion
JuriicrrteaOsto more rumour ... Doubts adaptive and maladaptiverisk. People volved in the attributionof behaviourin
general,successand failurein particuit"rt to enter our thinking' and the de- who enjoy driving Formula One cars
around a race track at weekends are lar.
becomea
vJtopingbearish.expectations
demonstralingadaptiverisk,i.e. they are After srrccessfulperformanceof a task,
self-fulfillingProPhecy.
only endangeringthemselves,and the individuals
tend to attributeresponsibility
Psychologlcal characterlstics ol
risk contributeslo personaldevelopment to lhemselves,but when unsuccessful
good Investors
and skill. Conversely,a person who attributecausalitylo otherfaclors(Miller,
Can we predict the psychologicalchar- jumps red lights or speedson motor- 1976).The moreextremethe successor
maladaptiverisk, failure,lurthermore,the more likelywe
acteristicsthat are likely to be associ- ways is demonslrating
i.e. recklessbehaviourthat is a danger are to attribule it to personalityfactors,
ated with the successfulinvestor?At its
most basic the answer is very clear suc- lo others,and is totallysellish.
whereas mediocrechanges in outcome
cesslul invstment is a resuh of good Adaptiverisk is more likelyto be associ- are more likely lo b attribuledto good
tuck. But is that all? What about intel- ated with successfulinvestmentin the
or bad luck. This also appliesto iudgeligence,drive,ambilion?
long term. Amongstth investmentana- ments we make about our own abilities
You would think that intelligencemight lysts and fund managersat work today, (Greenberg, Pyszczynski,& Solomon,
1982).
ihere will only be a few who have lhese
be important, il only to deal wi6 the
massive amounts ol informalion,which qualities and are successfulbecause of
So if I buy a share and its pricechanges
that
surely require analysis and mder- this. The majority,who also believe
"sucess", by some small amount,il says very little
their skill contributesto their
standing. I have already argued thal
about my skill as an investor;bul if the
will only be performingal market (i.e. change is very large then the profit or
mosl of this informationis irrelevantas
far as individual investors are cn- chance)level.
loss is attributedto my skill,or lack of it. I
cerned, since they are incapableof deal- Their belief in their own ability is quite am now seen as someonewho is eilher
inq with information on this scale. simplya delusion.
very shrewd,or is a fool.
Inielligenceis therefore not that importLet us assume lhat we have decided
The myth of consistent perlormance
anl. Drive and ambitionare importantas
a certainperson is a skilfulinveslor,
that
motivators and as aids to career devel- ls it possible for some invEstors to do
i.s. on lhe basis of evidence that we
of
the
sucas
requirements
but
opmnt,
consistentlybetterthan the market?
have amassed about an irdividual and
cessful investor,lhey are irrelevant
his investments.we concludethat he is
The Eflicient Market Hypothesispredids
The characteristic that is important is in- that, all things being equal,no individual knowledgeable in investmsnl malters.
dividualism. Investors who largely conwill perform better than another individ- We then learn that one of his investform to market opinion will on a\trage ual, except at chance level.The crucial ments has gone badly wrong; how does
never do better than the market itsdf. To
phrase is'all lhings beingequal'.
lhis change our impressionof this perdo betteFth individual must b do to
son?
lo
Given that all investors have access
stand up to the prsssure that will be felt
i.e. The chances are that it doesn't. We exthe
markel,
information
about
the
all
when Vhe makes investment decbions
"inside informatbn', then the
cuse this loss by attributingit to unforeexcluding
that are lar from popular.This meanswe
price
reflcl
funshould
seen venls, or just bad luck. But when
a
share
of
are looking for a person who is probably
are inetficien- this same investormakesa considerable
if
there
Only
damentals.
distinctive but not erlrovert; extroverts
gain, lhis is nol due to unforeseen
in the market in{ormation,and if
are loo concernedwhh their imago and cies
svents, or just bad luck, this gain simply
are able to exploitthis, will an
individuals
don't like unpopularity.
confirms our view that the person is an
investor be able to do beter than the
able inveslor.
market.
Adapttve rlsk:takers
Now this may happenon occasion,but We all have a very strongneedto under'
Risk-taking is another charactristb lhat
is il likely that the same individualcould stand our fellows and part ol this underI would bok for in the successful irvesbeen over estlSea oil forecasls have
a takeover/mergeris in. the of;;J: -hJtorr

The Psychologist

March1988

101

STOCK MARKET
fore feel a strong need to atlributethese
gains lo an individual'sskill. lt is becauseof lhis need to imoosesome sort
of order and predictabilityon our lives
that we will continueto deludeourselves
that certain investors can consistentlv
beat the market.

and
some
necssary.

readjustment

becomes

Finally, if we are to understand how

movments in the markets occur, we
musl locus our altenlion, not on ther
movements themselves, but on the
people responsible for the movemenls,
the investors. We need to know more
about the psychological factors that influence the ex;.ectations, assessments,
and decisions cf th individual investor.
Perhaps then vre will be able to understand and oredid the behaviour of lhe
markets.
REFERENCES
Asch, S.E. (1951). Effectsof group pressure
upon tre modificationand distortion of judgement. ln H. Guetzkow(Ed.) Groups,Leadership and Men. Carnegie: Pittsburgh
Greenberg, J., Pyszczynskl, T., & Solomon, S. (1982).The self servinganributional
bias. Eeyond self presentration.Journal ol Experimenal SocialPsydtology, 18, 56-57.
Keane, S.M. (1980). The elficient markethypothesis. The Institute of Chartered Accountants of Scodand.
Kogan, N. & Wallach, M.A. (1964. The risky
shitt phenomenonin small decision making
groups: a test ol tre information exchange
hypothesis. Joumal ol Experimental Social
Psychology,3,75-85.
Miller, D.T. (1976).Ego involvementand attributions of failure. Journal of Expimental
Social Psydtology, 34. 901 .
Schlarbaum, G., Lcwellen, W., & Lcase, R.
(1978). The common stock portfolio performance recordsof individual investors.Journal
ol Finance, 1964-70.May.
Sharpe, W. (1966). Mutual Fund Perlorman@. Joumal ol Business,January.

Concluslonand lmpllcatlons
The conclusionsto be drawn from this
discussionare obvious and ralher discouragingfor the private investor.ft ag
oearslhal it would be a wasteo{ time lor
the laypersonto aftemptto discoverbargain opportunitiesin the stock market.
Further, it would not be worthwhileto
pay for "experl" advice about under- or
overvaluedshares, since it is difficult if
not impossibleto identify such experts,
as track record is likelyto be a poor indicator.What then are we to do?
Most investorswant to regulattheir degree of risk exposure, i.e. maximize
gains and minimizelosses.This can be
achieved, not in respect to individual
shares,but certainlyover a well diversified portfolio.
standing involves forming impressions.
Once we have developedan impression It can be shown that a portfolioof 15
of someone, we ars very loath to give it sharescan achievethe optimaidiversifiup even when laced with contradictory cation effecl. But which 15 out of the
evidence.One consequenceol this is manythousandsshouldwe choose?lt is
here that the expe(ise of the investment
that the behaviourof people appearsto
be more consistent than it adually is, analyst and advisor starts lo be useful.
and in lhe investmentworld, it is this that There will always be a need for the layproduces th myth ol consistent perlor- personto obtain advice on the construction ol an efficient portfolio, and it will
mance.
probably prove profitableto consull the
Statistical evldence
servicesof these professionals.
Statistically,it is very difficuttto assess The second conclusion is that once a
the etficienq of an individual investor portfoliois selected,the investorshould PeterEacfrusis a Lecturerin Psychology
in
because. ?eiatlve to the market as a lolfow a buy-and-hold strategy. Since the ScierrceDepartment,SalfordCollegeof
whole. the indivi{tualcan never make there is no consistent difference be- Technology.
enough investment decisions. h has tween individual advisors, tipsters or
lllusfatiofts by Les Prince
however been attempted. One U.S. lund managers, then switching investstudy compared the rturns earned by a
ments will not achieve any significant
Doing Social Psychology
number of ordinary investorsover a six gains and will only generatetransaclion
year perbd with the returns earned dur- costs.The only exceptionto this is when
Laboratoryand Field Exercises
ing the same periodby:
the overallbalanceol the portloliois disEdiled
ry Glynis M. Breakwell, Hugh
'a group of expertlymanagedfunds;
turbed by charges in marketconditions,
Foot and Robin Gilmour
'a'buy the maftst and hold'
This colledion ol well-proven laboralory
strategy.
and lield exercisesengagesstudenls
and their inslruclorsin a thorough
It was lound thal the experts did no betexplorationof currentcentralproblems
ler or worse than the ordinary inveslor
and topics in social psychology.
and neithergroup outperformedthe marThe book providesstudentswith allthe
ket consistently.There were short perinecessarybackgroundknowledgeof
ods when they did better, but this was
each socialphenomenoninvestigaled
matched by periods of inferior perforto make their researcheffortinvolving
mance, i.e. il was probably a chance efmeaning{ul.lt instruclsthem in the
and
(Schlarbaum,
fect
Lewellen & Lease;
rationalefor the exerciseand in the
1978). A number of olher studieshave
proceduresnecessarylor collecting
lailed to find any expertly managed
data.
tt also olfers clear suggestionsfor
funds thal have consistentlydone better
data analysisand the inlerpretationof
than average. lt has even been sugresulls.
gested that success is inverselypropor
Doing SocialPsychology developed
lional to researchexpenditure(Sharpe,
lrom Social Psychology: A Practical
19 6 6 ) !
Manual,publishedby the British
So il appearslhat il an investorbehaved
PsychologicalSocietyand the
in a totally random way, he should still
MacMillanPressLtd. The materialhas
perform at a level equal to that of the
been updated,revisedfor a world
market indicators. But of course occamarket.and rewrittenfor directstudent
sionally,just by chance,he would hil on
USE.
the right combination of shares, and
Co-publishedby th Brilish
would do better than the market. lt is on
PsychologicalSocietywiih Cambridge
these occasions that attributionoccurs.
UniversityPress.BPS memberprice:
We find il ditficuh to accspt that large
e 11 . 9 5 .
gains could occur by chance and lhere-

The Psychologist

March 1988

103