There’s a pattern here… if you’ve been following our series on behavioural biases and how to combat them, you’ll know that for the last 15 weeks, we’ve published the latest update regular as clockwork. If you’ve opted to subscribe to emails, then once a week, every week, there’s the next instalment sitting in your inbox.
That’s pattern recognition. It’s really useful as a way to make sense of the world as we get through life, it helps us to notice when things unfold in a familiar way, which can mean getting ready to take advantage of opportunities, or being ready to run away from threats.
But our instinctive behaviours are often too zealous for our own good. The in-built desire to spot the familiar can lead to us spotting ‘patterns’ that aren’t really there. As an investor that can be really bad news. Here’s why.
A light breeze, a zebra or a lion?
If our ancestors were roaming the African plains and saw a rapid movement at the edge of their peripheral vision, the answer to the question above is really important. It could mean respectively, nothing to be alarmed about, the chance of getting a meal, or the chance of becoming a meal.
Since prehistoric times when our ancestors depended on getting the answer right first time, evolution has been conditioning our brains to find and interpret patterns – or else. It’s so ingrained that we can’t help ourselves – we’re always looking for the familiar and if we look hard enough, we’ll convince ourselves we’ve seen it. That’s why we see the face of Elvis Presley in our cappuccino, spend hours with a stub of pencil in the bookies convinced we have a formula, or insist that random events like 10 coin flips, all heads, will go on to have orderly outcomes according to a predictive pattern.
As Jason Zweig notes in ‘Your Money & Your Brain’, “Just as nature abhors a vacuum, people hate randomness”. He puts it down to a result of our brain’s dopamine-induced “prediction addiction.”
When is it helpful?
It’s helpful for cataloguing opportunities, flagging threats and staying alive. Had our ancestors failed at pattern recognition, we wouldn’t be here to speak of it, and we still make good use of it today. For example, we stop at red lights and go when they’re green. Is your spouse or partner giving you ‘that look’? You know exactly what it means before they’ve said a word. And whether you enjoy a good jigsaw puzzle, Sudoku, or Rubik’s Cube, you’re giving your pattern recognition skills a healthy workout.
When is it harmful?
Put simply, pattern recognition becomes dangerous when we start spotting patterns that don’t exist. When it comes to investment that’s an all-too-common and very destructive influence. There are no patterns in the markets – you can’t predict them and a period of similar movements doesn’t mean you’re ‘on a roll’ or having a spell of bad luck. Is any given stream of breaking financial news a predictive pattern worth pursuing? Or is it simply a deceptive mirage?
As an example of how easily our pattern-spotting ability can be wrong-footed, Zweig published a fascinating piece that shows how presenting financial numbers in red instead of black can make investors more fearful and risk-averse. That’s a powerful illustration of how pattern recognition can influence us – not only can it lead to us trying to make sense from nonsense, where there is in fact a pattern, we can very easily misinterpret it.
Given how hard it is to tell the difference (until hindsight reveals the truth), investors are best off ignoring the market’s many glittering distractions and focusing instead on their long-term goals.
Keep bias at bay
It’s surprising how hard it can be to simply let things be. Knowing why we react in the ways we do is the first step to avoiding the counterintuitive actions that can damage what we set out to achieve with our investments.
You can download Making Better Decisions: Know Your Behavioural Biases in full today.
Co-Founder & Director
Metis Ireland Financial Planning Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland.
All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified financial adviser before entering any financial contract. Metis Ireland Financial Planning Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts.