The Madness Of Crowds

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Thursday, 15 October 2009, 7.50 am and 7.20 pm)

The crowd of investors betting that the US dollar is going down the drain has just grown larger after Australia raised its key interest rate last week.

It’s like February 1995. Then, people were dumping the dollar like it was toxic waste. That turned out to be a mistake. Because the dollar rebounded from its low and rose for the next 7 years till February 2002.

So will today’s crowd of dollar bears be proven right? We’ll have to wait and see. At least, history tells us that crowds of investors tend to be wrong most of the time.

And that’s because we tend to buy and sell at the wrong time the wrong assets. We buy when everything looks perfect, and therefore, when prices are high. We sell at any price when an asset has been under selling pressure, and therefore, when prices are low.

Why are we so stupid? Actually we’re not. Sometimes, it is more efficient to follow the crowd. This is according to biologist Lee Alan Dugatkin of the University of Louisville.

In his famous 1996 study on female guppies, similar to those found in our monsoon drains, Professor Dugatkin found that a female guppy’s preference for a mate is strongly influenced by the choice of other female guppies.

Normally, the type of female guppy under study prefers a male guppy that is bright orange in colour. But if she notices that the other female guppies are going for a male guppy that is light orange in colour, she would switch her preference. She is even prepared to dump her previously selected, brightly-coloured orange mate, for a less colourful one.

Why? Apparently, it saves time to copy others. Instead of spending time checking out the potential mate, the bride-to-be female guppy would rather be eating, resting or looking out for predators.

Before this study was done, it was thought that the behavior of animals, especially guppies with virtually no brains, was determined by their genes. The environment, or social learning like copying, had no role to play.

Now we know better. The advantage of copying is that guppies acquire information faster and they can use them instantly. If the guppies relied on their genes alone to tell them what to do, it would take hundreds or thousands of generations of evolution time.

Professor Dugatkin also discovered two interesting findings. Firstly, young female guppies tend to copy the choice of older and more experienced female guppies. But older female guppies do not copy the choice of younger female guppies.

Likewise, we investors studiously follow what experienced investor Warren Buffet does. But he pays us no such attention.

The other interesting finding is why only female guppies were studied. Apparently, that’s because females tend to be more choosy about their mates in the animal kingdom. And females relied more heavily on the opinions of other females compared to males relying on the opinions of other males.

The study tells us that we human investors are no different from the female guppies. When we rush in to buy in a bull market, we save time by not analyzing the investments thoroughly ourselves. Since the crowd gets it wrong most of the time, we should be careful about following crowds.

The question that pops up now is whether the current bullish property market is driven mainly by the copying behavior of young female spouses trying to secure their homes. They are, after all, the real decision-makers in the family.