Chapter 5: Advanced Behavioral Finance and Market Psychology
Stock market news
Depending on what you follow daily, you'll often come across articles with headlines like "Look what this notorious bear is doing," "This bull is buying these stocks," or "This indicator has 100% accuracy in predicting recessions." These types of articles are what we refer to as stock market news.
Real or fake?
Some news might even be entirely fake, which can seriously impact your investment decisions if you choose to believe it. Fortunately, these fake stories are often easy to disprove by reading more articles on the same topic or by recognizing that they are so outlandish they can be dismissed from the start. Staying vigilant and cross-referencing information with reliable sources can help you avoid falling victim to misleading or false news, ensuring that your investment decisions are based on accurate and credible information.
Bending the truth
Unfortunately, it's becoming more common for news stations to use strategies that make it difficult to discern whether they're telling the truth. This is because sensationalized stories are more likely to grab attention and keep you engaged. Always look for facts when reading the news, as stories are often exaggerated to provoke fear or anxiety—essentially doing their job of keeping you thinking about it throughout the day.
A prime example of this is the "100% recession predictor" we mentioned earlier. In hindsight, it's possible to identify indicators that appear to have accurately predicted past recessions, but this often involves cherry-picking data. Anyone can find a "100% predictor" for previous time periods, but that doesn't mean it will predict future recessions accurately. Each economic cycle is different, and past performance is not necessarily indicative of future results.
Another issue is that even if an indicator has a 100% success rate in predicting recessions, it might also have a high rate of false alarms. For instance, if it predicts recessions with 100% accuracy but also triggers three false alarms for every correct prediction, is it really a reliable indicator? Such a tool could cause unnecessary panic and lead to poor investment decisions, highlighting the importance of critical thinking and thorough research when evaluating such claims.
Should you listen to the news?
We believe there's almost no reason to rely on the news for two main reasons: If a news story were truly as significant as it seems, you'd likely hear about it from multiple sources and feel its impact in various areas of your life, not just from a single article or news channel.
News often prompts you to take action, which can be one of the most dangerous things for your investment portfolio. Reacting impulsively to news stories can lead to hasty decisions that might not align with your long-term strategy or investment goals.
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If you're determined to watch the news and stay updated, it's important to approach it with caution. Consider treating the news as a "what if" scenario or some other perspective that reminds you it's not necessarily reflective of reality. Alternatively, try to disprove the news story—if you can't, then it's more likely to be real. Regardless of what you read, it's crucial to avoid taking any immediate action based on the news. This helps protect your investment portfolio from impulsive decisions that might not align with your long-term goals.