The Problem With Patterns

by Mr. Cheap

I recently had a funny experience. In late October, financial stocks took another dive (at one point my BMO and NA were down about 10% from my average purchase price). The yield kept climbing, and I just couldn’t believe Canadian banks were going to go out of business, so I was tempted to buy more. Speaking with a friend, I quickly talked myself out of this (I’m not working right now, so the purchase would have come from a LOC, which probably isn’t the smartest idea).

Fast forward a week, and the stocks have almost gone back up to my average purchase cost (NA was $50.50 on October 23rd, and its $54.20 and climbing as I write this on Oct. 31st). I’m looking back, seeing that my feeling was correct, and that I missed out on some rapid increases over 8 days.

So next time, I’ll trust my gut and buy? No I won’t.

Humans has a remarkable pattern matching ability that helps us figure out what’s happening in our environment, and predict what will happen in the future. In many areas this is very helpful, but in a few it can cause weird behaviours or hurt us. Optical illusions play on our pattern matching to confuse us. Gambling preys on this pattern matching where we think we’ve figured out what’s going to happen (and trust the feeling as we lose all our money).

If NA had been guaranteed to make a speedy recovery and shoot up in value, institutions and other investors would have been buying it while it was dropping and would have never let it go as low as it did (they wouldn’t leave money on the table). There was some risk that it would drop further, or it would have stayed at its lower value for an extended period. Its price reflected all these possible future outcomes.

I was interested in my own reaction when it went up, because first I thought “I should have bought”, then I thought “I should buy in a similar situtation in the future (since I was right this time)”, then I thought “wait a second, this is the *EXACT* feeling that gets people into trouble!”.

Unpredictable things are unpredictable. Once you start feeling that you have an intuitive instinct about what’s going to happen (or worse, some arcane technical analysis formula that will predict it) you’re turning into a dangerous gambler. Beware that siren’s call, as it could lead you to your doom.

Be Sociable, Share!