Causal Connections

A lot of research has been dedicated to trying to understand irrational human behaviour. Everyone is prone to such errors. It is the way we are built.

Irrational thinking especially manifests itself when dealing with something very close to everyone's heart: MONEY. However, understanding potential flaws in your thinking will make you more aware of how these may affect your investing behaviour.

For instance, our mind is wired to automatically search for causes behind a piece of information. The problem is that, more often than not, these 'causes' are instead erroneous assumptions based in fiction rather than fact.

Here is a simple example:

In December 2003, headlines blared about the capture of Saddam Hussein.

At 1301 hours, Bloomberg News reported that US Treasuries rose (a sign of risk aversion) — because Hussein's capture might not curb terrorism.

Exactly half an hour later, at 1331 hours, Bloomberg News reported that US Treasuries fell (a sign of risk-taking) — because Hussein's capture boosted the allure of risky assets.

How did the same piece of news cause two different and totally opposite market events? If we were to sit down and quietly think about it, we would find it more plausible that the rise and fall of US Treasuries was due to some other unrelated event — investors buying and selling according to their own requirements and needs, rather than because of one man's capture.

Every day, we read headlines that are designed to be emotionally charged and make us bypass logical thinking for fight or flight mode. We need to recognise this tactic and refuse to fall prey to it. Always take a step back, and refuse to make any rash decisions without first thinking things through.