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Monti_MarcoThe powerful emotions of fear and greed have played havoc with markets throughout history–helping to create bubbles and crashes. Spurred by strong feelings that often trump rationality, individual investors too often buy high and sell low. And, since people also  fall prey to the herd instinct, millions of  individual emotional reactions combine to create massive market phenomena capable of destroying many trillions of dollars in wealth and crippling economies. The global economic crisis of 2008/2009 is a dramatic and still hurtful example of fear and greed at work.

So how can we humans get smarter about investing? Through a combination of analytics and data visualization. Marco Monti, an Italian scientist who was hired by IBM in July, is developing methods that investment advisers can use to help investors make wiser long-term decisions. “Technology will allow us to develop a better understanding of behaviors and the role of emotions like greed and fear,” says Monti. “I hope we’ll be able to help common people who are not experts understand that those emotions should be considered over a long perspective. They shouldn’t be a cause for impulsive action.”

Monti does applied research for IBM’s analytics consulting business. He’s a specialist in cognitive sciences and the psychology of decision making with a Ph.D in economics from Bocconi University, in Milan. Through a pre-IBM project, Cognitive Banking, which he led as a post-doc for the Max Planck Institute in Germany, Monti established that if investment advisors had a better understanding of the needs of different kinds of investors and the most effective ways of communicating with them, they could improve decision making and investment outcomes.

Now he’s combining data visualization techniques with other analytical tools to come up with ways of using visualization to get through to people with different levels of financial sophistication. “You can use a more metaphorical language for people with low skills and more statistical visualization techniques for more sophisticated people,” he says.

It’s interesting–and encouraging–that the the power of vision can be used to overcome the powerful motivators of greed and fear.

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Interesting, but ultimately, I think it’s a pipe dream. Not because this technology isn’t worth pursuing nor because I think it’s not excellent technology. But because fear and greed have always been, and will always be, a core part of human psychology and trading and investing merely heightens these parts.

Any systems or analytics created to mitigate fear and greed are created by humans. These systems are also based upon certain assumptions of how markets work, but markets change constantly.

The financial meltdown was the result of fear and greed. But much of idiotic risk-taking resulted from supposedly advanced analytical models that were designed to mitigate risk. Oops. Guess it didn’t work out that way. The problem with such systems is that they’re programmed to current or past market conditions and are unable to consider any situations other than what they’re programmed to do.

But great traders of any era know one simple truth about the markets: prices are not created by models. Prices are created by other participants in the market. It really is that simple. The great traders and investors don’t trade prices, models, advanced analytics or anything like that. They simply trade or invest against the other people in the markets. While they may use advanced tools, they only use them in the context of analyzing data in ways to illuminate who else in the market and where they’re positioned.

Oh, and if you want to look at fear and greed, look no further than the 800-pound gorilla in the room: The Federal Reserve. It amazes me, that with so much talk about why this mess occurred, almost nobody realizes that all of it – and I do mean all of it – can be traced to the Fed’s manipulation of the currency and it’s very cozy relationship with the world’s biggest banks.

And no piece of software is going to solve that problem.

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Posted by: lamedraiprorm
September 28, 2010
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The problem is people have a hard time interpreting information because it is too hard to put together.

Aqumin could save Marco some time- we already invented real time market data visualization –

I would be happy to help Marco out.

Posted by: Andrew Giovinazzi
September 24, 2010
11:02 am

High Frequency Trading (HFT) accounts for over 70% of equity trades taking place in the US. This means that 70% of the daily trades in equities, options, futures, ETFs, currencies, and all other financial instruments that possess electronic trading capability are done by computer programs holding short-term positions. No emotions are involved.

On the afternoon of May 6, 2010 the Dow Jones Industrial Average (DJIA) dropped approximately 600 points (5.7%), and then quickly recovered. Other Major Market Indexes dropped by similar amounts. This event had nothing to do with ‘millions of individual emotional reactions combine to create massive market phenomena capable… ‘. On May 6, 2010, starting 14:42:46 and ending at 14:47:02, there were hundreds of times that a single stock had over 1,000 quotes from one exchange in a single second without any economic justification for this. In many of the cases, the bid/offer was well outside the National Best Bid/Offer (NBBO). Research concluded that what happened can only be evidence of either faulty programming, a virus or a manipulative device aimed at overloading the quotation system – quote stuffing. It is obvious that we have bigger problems than greed and fear in investing.

The subject of visual analytical tools being used to overcome powerful motivators, while not relevant in investing, is very interesting. I wish we had a better example of its application.

Posted by: Marius Ghercioiu
September 21, 2010
4:31 pm

Interesting. I saw a video clip of a Malcolm Gladwell leadership presentation the other day, and he also attributes poor decision making to over-confidence, regardless of the amount of information people have. He talks about an experiment involving this concept, here:

Just something to noodle on.

Posted by: Jenny Sussin
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December 21, 2012
1:04 pm

[...] wrote a couple of days ago about IBM’ researcher Mario Monti in a blog posting called Better Decision Making: How Analytics Can Counteract Emotion in Investing. Then along comes word of the impending publication of a new book by Meir Statman, a professor at [...]

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