The Parable of the Ice
I couldn’t remember the exact year. It was probably 2003 or 2004. I happened to visit a nearby bookstore and found a copy of a book about Marc Faber.
The first cover intrigued me. It was actually the reason why I bought the book. I couldn’t put it down.
It was a parable. Not really a parable. Maybe an analogy of how individuals think.
It’s Marc Faber’s vision.
Here goes. (Note: It’s altered. Not the exact words)
Imagine it’s a bitterly cold day. You went outside your house with your coat on. When you turn a corner you could see a frozen pond.
You ask yourself: Should you risk taking a short cut? You’ll probably get to your destination in 10 minutes. But your logical brain tells you that it’s safer to walk to the bridge but it would take you half an hour to reach your destination.
Here comes a quick problem: Do you take the short cut but risk yourself if the ice breaks? Or do you take the safe and long method?
Then you see a man dipping his foot on the ice. Then the second foot. A young woman followed his lead. Minutes after there are already children skating. It seems everyone is having party on the ice.
The young woman got his confidence from the man. The children from the young woman. And so on and so forth.
Each person has given the confidence to the next person to join the ice party. The more person on the ice the safer it feels.
Seems logical, no?
But wait. You turn around. Then you hear some crack and first scream.
—
This happens to us most of the time. I get a lot of that.
Remember the times that you go to a restaurant and ask for the best seller plate? I do. That’s the first thing I ask when I go to an unfamiliar restaurant.
It’s called the Crowd Mentality Disease. CMD for short.
It’s when we buy something and look at the testimonials of past buyers.
It’s when we ask 10 opinions from different people which will be the best shoes to buy.
It’s when vote a President because he’s leading in the survey. A lot of PR firms do that.
But wait, is there wisdom in crowds?
How could a million people be so wrong about something? Of course, there’s always the feeling of safety when you have other people with you.
There’s a book called wisdom of crowds. I haven’t read it.
Based on my understanding, the book identifies elements for a crowd to be wise. One of the factors is independence. That’s independence from the opinion of others. It means that if you collect diverse opinions to form a valid group opinion, you get a powerful decision.
This is very much different with group-think. In group thinking, people based their opinion on other people. The result is poor and biased decision.
CMD is rampant in finance and investing.
Look at the forums. Take yahoo forums for example. You see two sides of the argument – a bull case and a bear case. When the stock is falling, the bears are the ones actively posting. Conversely, when the stock is rising you’ll see a lot of bulls doing the talking.
I admit I’m as guilty as hell.
I bought a regional bank stock in 2009. Read some few annual reports. I bought it because it’s super cheap, or so I thought. I went through the forums to see how other people think about the stock.
Since I am bullish on the stock that it will recover, I skip the bear comments and focused on the positive ones. I was looking for confirmation that my opinions are valid. It gives me confidence.
But it’s dangerous. I was getting emotional. It’s not easy. I became addicted to the forum boards. When somebody thinks that it’s going south, I was tempted to sell. It’s not easy. And then I’d be happy if someone posts something positive.
Later the bank was liquidated and I lost some money. I should have tried digging on the facts more rather than spending time on forums.
I should have just lost money and spare the nights that I was worried whether the bank would really go south.
How do we deal with CMD in finance?
Have an independent opinion based on facts and your analysis. Shut down the crowd but not totally. Look at the “bear” case if you’re a “bull.
And please stay out of forum boards. How about non-finance related CMD issues? Always question other opinions and build a strong inner scorecard.
Got CMD combat tips? Share your experiences and tips in the comments box.
