Why Our Expectations Run the Markets

Investing, basically

by Ben Carlson, A Wealth of Common Sense

“Perceptions of future stress are felt now.” – Richard Peterson

From Richard Peterson’s Inside The Investor’s Brain:

Researchers examined the stress responses of two groups of rats after they were subjected to painful electric shocks. Group 1 received painful electric shocks 10 times per hour, while group 2 was shocked 50 times per hour. The second day, all rats were shocked 25 times per hour. At the end of the second day, rats from group 1 (who experienced an increase in shock rate) had elevated blood pressure (a physical sign of stress). Rats from the second groups (who experienced a decrease in shock rate) had normal blood pressure.

This analogy basically explains how the financial markets work.  It’s not just that things are good or bad that matters.  It’s generally about things getting better or worse.  The markets move because investors view the world in terms of relatives not absolutes. There’s an old saying is that it’s the reaction to the news that matters, not the news itself.

This is also a useful way to understand investor psychology.  Each investor’s perspective about the future says a lot about how they will react to the present situation.

Expectations are everything in the markets.  Some investors set their expectations too high while others set their expectations too low.  Which of course leads to overreactions one way or another when actual results are better or worse than expected.

Source:
Inside The Investor’s Brain

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