Came across an article (link here) about someone leaving Ray Dalio’s Bridgewater Associates to set up a muffin shop called Double or Muffin. The idea is that customers will be given a coin to flip: Heads, the customer gets another muffin for free, Tails, the customer keeps his one muffin.
The concept is very interesting, as it is the same concept used in gambling to keep people addicted to playing, i.e. giving random rewards (think slot machines).
This is a pretty well-studied phenomena, where random rewards are more motivating than predictable ones:
- Quote from here: “A dolphin rewarded with a fishy treat every six jumps will soon become lackadaisical about the five in-between ones; reward it at random, however, and it’ll jump vigorously, never knowing which jump will bring fish.”
- Quote from here: “In the 1950s scientists discovered that rats which had been trained to feed themselves by pressing a lever, would press it obsessively if the food was delivered randomly… …. People have discovered that this works on humans as well. If you give people a lever or a button to press and give them random rewards, they will press it all the time.”
You see this phenomena being exploited in various places: casinos, arcade machines (e.g. those coin pusher type boxes), and in computer games (e.g. random special items, think about chests that contain random items or monsters that drop random loot). Now you know why such things are so addictive.
And here’s an interesting twist, animals will tend to attribute the random rewards to some superstitious thing in an attempt to explain the random rewards.
Quote from here: “When BF Skinner gave pigeons food randomly, the birds developed odd repetitive behaviors. The pigeons performed strange dance-like behaviors: turning in circles, poking their heads toward corners of the cage, or repetitively tossing their heads. Skinner called these dances superstitious behavior. The silly pigeons increased their rate of superstitious dancing, even though their dancing was not the cause of the food reward. Skinner argued that humans also display superstitious behaviors unrelated to rewards – such as rituals related to luck.”
Playing the Market
In a way, these psychological behaviors manifest themselves in the market as well. People playing without a proper system and keeping at it because the market gives them random rewards, and people having all sorts of superstitious beliefs about what is causing them to, or required to, make money.
Why People Hold on to Losses All the Way Down
Lastly, on the topic of psychology and trading, I recently realized that one of the psychological factors that contribute to people holding on to losses and ignoring stops, is not just the fear of losses, but a negative side effect of our adaptability. Humans have great adaptability to all sorts of situations, and I believe one way we do that is the continuous shifting of our reference point.
For example, you buy a stock at $100, that becomes your reference point. The stocks drops to $95, a $5 loss. The fear of losses and the hope that it would rebound immobilizes you from immediate action. It then moves around $95 for a while, and your reference point shifts to $95. It then drops lower to $90, another $5 loss. While it is a $10 loss from your buy point, most people would only think of it as another $5 loss, because their reference point has shifted to $95. As the stock lingers around $90 for a while more, and then drops lower to $85, its just another $5 loss from the new $90 reference point. You get the idea. Before you know it, you are down a huge percentage, and you are just waiting to sell to break-even.
This adaptability is similar to the old story that you can boil a person’s hand if you start the hand in room temperature water and very slowly increase the temperature. We detect large changes quickly and easily, but we get caught when the changes creep up to us slowly over time, which is what the market does.