Social Proof in the Markets

The world has a strange way of not ending, despite the prognostications for the end of days by a number of cult leaders over the years.

One such false prophecy was studied by a group of researchers from the University of Minnesota who joined a cult in Chicago incognito to study it from the inside. The leader of this cult, Marian Keech, told her followers she was being contacted by a group of spiritual beings from space called the Guardians. Mrs. Keech said the Guardians were telling her there was a great impending flood that would eventually engulf the entire world.

She informed her followers that as long as they followed her teachings they would be spared, as spacemen in flying saucers would carry them off to another planet. This group of roughly 30 people was extremely committed to the cause, as they sold all of their possessions, quit their jobs or stopped going to school to prepare.

When the date Keech predicted the flood would hit came and went a funny thing happened to these believers. They didn’t have a sudden realization they’d been duped. That would be admitting that their entire belief system was wrong. So they simply shifted those beliefs by becoming missionaries to tell others that the end would be coming soon enough. If they could only convince others of their message, then surely that message would have to be correct.

Robert Cialdini explains why this happened in his book Influence: The Power of Persuasion:

So massive was the commitment to their beliefs that no other truth was tolerable. Yet that set of beliefs had just taken a merciless pounding from physical reality: No saucer had landed, no spacemen had knocked, no flood had come, nothing had happened as prophesied. Since the only acceptable form of truth had been undercut by physical proof, there was but one way out of the corner for the group. They had to establish another type of proof for the validity of their beliefs: social proof.

Social proof is the idea that we look to others to figure out what the correct behavior should be. We follow narratives instead of evidence. It feels more comfortable to go along with the crowd when making tough decisions because we look at what others are doing in times of uncertainty.

It’s not enough to simply go against the crowd to be a successful contrarian — you also have to be able to think for yourself and get things right.

At times, that means admitting you’re wrong and learning from past mistakes, something that’s easier said than done when we become wedded to a certain belief system. That’s why I loved this passage from Ray Dalio in a recent piece he wrote for Esquire:

I predicted the Latin American debt crisis in the early 1980s, and I got a lot of attention because I was right. I was asked to testify before Congress, and I told them that I believed we were going into a depression. As it turned out, that was the exact bottom of the stock market and the beginning of one of the greatest bull markets ever. I couldn’t have been more wrong. I lost clients, and I had to borrow $4,000 from my dad. I had to wrestle with the question of whether I would actually put on a suit and tie, get on the commuter train, and get a Wall Street job. I didn’t want to do that. I ended up staying at Bridgewater, but that experience changed my whole attitude completely. It shifted my mindset from thinking, I’m right to asking myself, How do I know I’m right? It gave me the humility I needed to balance with my audacity.

Being right is easy. How you handle being wrong is the true test of any successful investor or decision-maker.

One of best parts about the markets is that they provide a running scoreboard of your decisions. You can see your win-loss record by simply looking at your performance. Unfortunately, when people are wrong about the markets many don’t balance their audacity with humility. They move the goalposts or change the narrative to fit their current worldview. This is why investing based on your ideological views can be so toxic to your bottom line.

Many investors assume they must be right no matter what the market does.

I’m not wrong, I’m just early. It’s the market that must be wrong and all of those other idiots, but surely not me.

One of the most fascinating aspects of the markets today is that most investors assume everyone else must be crazy. Those who have been sitting on the sidelines in cash assume everyone in the markets at current valuation levels must be nuts. And everyone who is sitting on gains from being invested in the markets assumes that those who are worried must be nuts because they’ve missed out. Maybe everyone is right (or no one) depending on the time frame.

I try to have strong beliefs but keep them weakly held by doing the following:

  • Saying “I don’t know” more often than not.
  • Creating my own too hard pile.
  • Seeing both sides of a trade or argument to understand what I might be missing.
  • Understanding that there’s more luck involved with the wins than I may care to admit.
  • Constantly re-examining my previously held views in light of new information.
  • Making room for enough self-doubt and humility to keep myself honest.

These things aren’t always easy but the alternative is taking the markets too personally and worrying more about sounding intelligent than making money.

Influence: The Power of Persuasion

Further Reading:
Cialdini’s 6 Principles of Influence & Persuasion


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