Van Eyk recently shared an article showing how confidence drives behaviour. Most of their article is republished below.
The TV show National Geographic Brain Games ran for nine seasons and entertained viewers with experiments and findings on brain function and biases.
One basketball experiment stands out as pertinent to the current economic environment and it has to do with our responses to positive and negative feedback. This experiment has been repeated many times by sports psychologists, with similar results.
You can watch part of the video here: https://www.youtube.com/watch?v=kO1kgl0p-Hw
First, each person stands on a basketball court and takes 10 free throws. Each time the ball successfully goes through the hoop is recorded. This score becomes the baseline. Naturally, scores range from zero to a perfect 10.
The next part of the experiment involves taking a few more shots but with two key variables. A blindfold and a crowd.
The crowd cheers loudly as if the ball went in upon the first blindfolded attempt. The shooter thinks they made the shot (whether they did or not). This is repeated on the second throw to erase the feeling that this may have been a fluke. Overcome by the positive reinforcement of a crowd. It is now time to see if the subject can better their baseline score.
Now, with positive reinforcement a low score is generally improved upon on the second attempt of 10 free throws.
But what about the high scorers, the near-professional basketballers, who scored high with their first 10 free throws?
This time, the experimenters take a different approach. There’s still the crowd and a blindfold, but this time, irrespective of whether the ball goes in the hoop or not, the crowd sighs at a ‘miss’.
You might guess where this is heading, but when the good basketballer takes the next 10 shots without the blindfold, they tend to score less than their baseline score.
What has happened in both experiments, according to Johns Hopkins University’s Sri Sarma, is attributed to the neuroscience of self-confidence. Those who received negative feedback, whose scores got worse started to doubt their own abilities and their brain created negative thoughts which had a negative impact on their performance.
Conversely, the positive reinforcement led to a calming influence on the brain, giving test subjects the confidence to improve.
What is interesting is that the positive experiment works almost every time.
The point is, on both sides of the experiment, nobody’s skill or expertise is getting better or worse. Rather confidence has the influence to drive results.
Applying this to investing, investors need to be aware when they are getting negative reinforcement – particularly from the media – it may just be short-term noise. Likewise, positive reinforcement should not encourage investors to take ill-considered risks.
Right now, as interest rates have been rising, there has been a lot of negative feedback about the economic outlook. Some predict an economic slowdown will occur.
Professional investors, like the basketball players, should be better at filtering this out.
The first graph below shows the calendar year returns of the Australian stockmarket since 1980:
First you note there is no real pattern, except that negative years are usually followed by positive years. But the ride is bumpy, meaning investor confidence can vary. However, as the graph below shows, if you remain in your seat throughout the volatility, you are rewarded with $1 growing into $88:
Many investors missed the share market rally at the beginning of 2023 after their confidence may have taken a hit in 2022. Many confidence-hit investors also missed the post-COVID rally in 2020. It is important investors understand not to retreat when negative results or headlines abound.
Nor should overconfidence encourage additional risk-taking or make you ‘fall in love’ with a trade because it did well. Assess portfolios, not on the recent past, but over your investment horizon or the long term.
Daily exposure to newspapers, books, and online media with information about stock markets and bonds is accessible to everyone. The media’s agenda remains “fear and greed” because articles or stories with one of these as a central premise attract eyeballs.
Applied to investing, if people listen to the constant negative feedback from news etc, they may perform worse. They need to learn to tune out the noise, like these people shooting need to tune out the negative/positive feedback.
Author: Rick Walker
Source: An investing lesson from neuroscience: Beware the feedback (vaneck.com.au)
