The Road Less Travelled: How Not To Think Like Others (Contrarian Thinking)

Sanjeev

Sanjeev

The population of the world is divided along many dimensions. There are physical dimensions, like fat people/ thin people, brown/ white people, etc. Then there is the psychographics, ie some like it hot and some like it cold, etc. Among the many other dimensions, one of the most important is the “behavioral dimension”, ie, the predilection to behave in a certain repeatable/ predictable fashion. The economic aspects of this kind of behavior are of great interest to marketmen.

Until now, Classical Finance studied human beings as static and uni-dimensional objects, whose aggregated behavior was reducible to mathematical formulae. If that was not so, it was not worth studying, said the professors.

Practitioners, however, found their way around the professors. A new pseudo-science emerged, which found believers among practitioners, although it has still gained wide acceptance among academics. “Believe if you want to, don’t if you don’t want to, but it works”, said some of the best traders in the world. But you cannot call this “research”, because it does not meet the rigorous standards of a ‘science’, said the academics.

Stanley-Danko put out a surmise that went somewhat like this: the world is divided into people with two distinct categories of mindsets, the ‘majority’ mindset and the ‘contrarian’ mindset. The Majority set is the dominant figure, with 97% belonging to this club (he quoted a more exact number, but I don’t want to get mathematical). Only 3% are Contrarians.

The twist in the hitherto predictable tale is more than 80% of the millionaires came from the latter (Contrarian Thinking) community. Danko came up with some other surprising findings, which were severely attacked for their lack of “rigor”. But they made intuitive sense and can be verified anecdotally by observing people around you.

The Tell-tale Signs of Contrarian Thinking

The “millionaire mindset” (also called contrarian thinking) is happy to be dowdy and unfashionable. Most American millionaires don’t live in fashionable areas. They live wherever they started from. A spectacular example is Warren Buffet, who still lives and eats at the same place he started from, way back in the fifties. They choose convenience and functionality in everything they do, not “status”. It is the millionaire wannabes that buy all the aspirational products that denote millionaire-hood, not the millionaires themselves.

They don’t change cars for the sake of (change), they often buy second-hand, low-depreciation cars, they mostly stay married to the same woman, and their children are often brought up with the same “middle-class” values that got them there.

The Great American Consumption

So where does all the garishness of American consumerism come from? From the high-income earners, NOT the millionaires. Income does not create wealth, the (millionaire) mindset does. The majority mindset pursues high income, thinking that income creates wealth. The contrarian thinking pursues a simple, unfashionable lifestyle, creating wealth by saving and investing whatever little income he gets. Understanding this subtle difference would be very good for all of us.

People with contrarian thinking distinguish themselves with a keen sense of balance. To use a driving paradigm, it is often said that all good drivers may not be good investors, but all good investors are good drivers. That is because good investors can balance out 2 very important ‘linearities’ evident in the majority of the population. One, they can understand the need to have an objective different from the crowd.

For example, most ordinary people get into a car to go fast, so they then go fast……..the logical linearity. Good investors know that you enter markets to get a high return, but after you enter the markets, you should focus on managing risk/ downside….the return will take care of itself. Similarly, you get into a car to drive fast, but after you are in the car, you focus on maximizing safety. In this manner, good investors avoid the linearity that is a characteristic of most “majority mindsets”.

A Contrarian as an Investor

The second linearity is called “self-attribution bias”, ie the tendency to attribute all successes to yourself, and to simultaneously externalize all failures to bad luck, the other car drivers/ market. The ability to behave in a manner that assumes and incorporates the (anticipated) mistakes of others, is an ability unique to good investors. In driving, the majority of drivers (about 85%) believe they are good drivers, something we know (at least in Delhi) is simply not true. This is simply over-confidence, seen very commonly in bull markets. In fact, in mature bull markets of the kind we see right now, this behavioral characteristic is pervasive……..that all investment success is internalized (“it was MY stock-picking that did it”) rather than the more humble “I was lucky to make money”.

The difficulty in classifying people based on behavioral orientation (like contrarianism) is that human behavior is neither constant under all conditions nor scientifically measurable. A fat man is fat under all earthly conditions, and measurably so. So patterns can be attributed to “fatness”, which can be scientifically validated. But ‘research’ into contrarianism must stay anecdotal, and only those who find these patterns intuitively acceptable will be influenced.

The Science of The Crowd

However, there is an emerging well-spring of information on this unique pattern of behavior that is now finding its way into serious academia. The first, most interested readers are traders in financial markets, who are the first to admit to “groupthink” and its damaging consequences. Locating and rooting out “groupthink” is not yet a priority in corporate boardrooms, probably because we cannot trace the damage back to it (groupthink). In another example of “self-attribution” bias, most corporates can externalize their misfortune to chance, the previous management, or the Government. There is little introspection to locate the problem within, which is a known characteristic of crowd behavior.

Crowds, especially large crowds, are monolithic, unthinking, linear, and incapable of introspection. They are intolerant of contrarian thinking, and reject any thoughts that fly in the face of “common wisdom”. Contrarians have learned, under the pain of death, to live a dual existence……..a public “yes man” who keeps checking back on his contrarian thinking to see if has missed out on something.

How to Park Your Car

Here is a little exercise that you can do, to assure yourself that these (2 mindsets) exist. Next time, you are in a long linear car park, check the ratio of cars parked with their noses in (towards the curb) and the cars parked with their noses out (towards the road). Take many readings of this ratio, and calculate the average.

I think 2 psychological patterns drive this number:

One is the tendency to postpone pain (pain aversion), by which humans generally choose the option that postpones any pain. That is why we postpone a visit to the dentist, and in stocks, why we sell our winners and keep our losers. It is easier to park your car with the nose facing inwards, even though it increases the inconvenience and risk of taking your car out backward.

Two is the tendency to herd. As more and more people park their cars with their noses facing inwards, the new cars coming in will tend to do the same. The paradigm built by the ‘system’ creates “culture”, which promotes linearity, even if it is irrational. So it becomes a sort of ‘rule’ to park with your nose facing inwards. I know that this is so, because (in my housing society) I have often parked all my 3 cars together with their nose facing outwards, and then checked to see what the others do. I find that the cars around my cars are often parked with their nose facing outwards, but generally, the others are parked with their nose facing inwards.

Over the last 8 years, I have taken hundreds of readings of this ratio across maybe 10 cities in 8 countries but always found the ratio to vary around 3 out of every 100 (there are outliers at times). I wonder if this can be called “research”. 

The existence of linearity in the Majority Mindset takes on differing hues, ie, it varies. Beyond a point, it gives rise to a ‘double-feedback’, which is the source of such great volatility in markets. It happens rarely but is remembered because it creates tsunami-like destruction of wealth among the populace. Maybe we have one building up just now.

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