Probabilistic or Limbic?

Contributed By : Prashant Shah, CFA

The human mind is truly remarkable. And difficult to understand in its (il)logic & (lack of) thought process. Looking at the behaviour of people around me, many a times, I get an appearance that we lack the critical thinking ability & (re)act only with short-term conveniences and achievements in mind.

Morgan Housel states in one of his blogs that “Most people understand probability, but few people actually believe in it”. But I have a belief that people don’t think in probabilities. In fact, they don’t think, period.

Why do I believe so?

Look at the Index movements in the past 2-3 months. Based on the peak hysteria in the months of (end) March, April & May, it appeared that the world was coming to an end and no business was going to survive the pandemic. Then suddenly, from the last week of May, when the first phase of end of lockdown was announced, the feeling was that everything was hunky-dory and would go back to normal now (immediately). Not many investors sat back and thought to themselves “Hold-on, let me just try to understand what’s going on here. Or better yet, let me just sit-back and wait & watch what happens. Once some clarity emerges I will take a call on the next course of action”.

Most either panicked & sold in the fall or panicked & bought in the rise. But the key emotion here is panic. Fear associated with our limbic system which is our reptilian brain and rarely in control of us.

And then they cry and complain about their bad luck, the markets are for gamblers & speculators or that only people with unholy nexus can make money in stock markets. Not many pause to think about what is it that they did & where did they go wrong & how they could do things differently next time.

Some readers may disagree & mention that people bought or stayed invested during this period. Maybe they were suffering from loss aversion bias or, highly unlikely, they were the rare breed of investors who actually decided to assess the situation and the impact on the economy & businesses.

My second observation is from out of the markets. What I see on the roads and around me are people observing the rule of wearing a mask when outside. But then they don’t follow the other rules of safety. When riding a vehicle, most don’t use protective gear; some don’t bother to drive on the right side; or use the footpaths when walking. Some completely dispense with niceties like not blocking the road when parking their vehicle.

Is the probability of catching the virus by not wearing the mask higher than the probability of getting hurt (or worse) from flouting the rules?

Why have the authorities been able to get us to wear a mask, but not been able to get us to follow the basic rules of safety? And more disturbingly, they have also adopted the normality of ignoring rule breakers, except when they may not be wearing masks.

If we could think in terms of probabilities, we would understand the risks of flouting the law to ignore safety and the consequences of these if the risk materialises.

The last 2 months has again demonstrated to me that humans are driven primarily by their limbic system rather than any rational thought process. I already knew it, but to see it working in real time is a different thing altogether.

As to what did I do in the markets? I used my behavioural biases of confirmation bias, regret aversion bias, loss aversion bias & anchoring bias to good use and waited and watched and will continue to do so.

About the Author:

Prashant Shah, CFA is part of the treasury team at Serum Institute of India Pvt. Ltd., the world’s largest vaccine manufacturing company, based out of Pune. He is responsible for advising on investments in direct & indirect equities, both public and private, & alternate investments. He has almost 2 decades of varied experience across multiple roles in areas of investing, finance, product development and entrepreneurship. He has been a CFA charterholder since 2015.

Prashant has been an active volunteer at the Pune Chapter of CFA Society India since 2012, when the chapter was set-up. He is currently Co-Chair of Professional Learning Committee of CFA Society India.

Prashant is an avid reader, a keen student of human psychology and an occasional blogger.