Belief

In a great book Six Impossible Things Before Breakfast the author, Lewis Wolpert, writes about the nature of belief. Investor should find this book interesting as it deals directly with the formation of mental models which could be wrong.

“The word belief, while freely and widely used to account, for example, for causes is nevertheless not easy to define. Neither philosophers nor scientists have been successful. David Hume, my hero philospher, said of belief that he regarded it as a great mystery. And some 200 years later, Bertrand Russell recognised that belief was a central problem in the analysis of mind. For many, belief is intimately associated with religion, and religious beliefs will be dealt with in detail. It is the everyday use of the word that I deal with in this book, and I will focus on those beliefs that relate to the causes of events that affect our lives in significant ways. Beliefs relating to moral issues will receive much less attention.

The anthropologist Rodney Needham has analysed the origins of the word belief. In Middle English, from around the twelth to the fifteenth century, the verb bileven already had the sense of believing in a religion, of being valid or true, of having a convic­tion. Going further back, one finds galifan in Old English and galaubjan in Gothic - laub is related to the Indo-European to love, want, desire. The English concept of belief is clearly linked to Christianity and the acceptance of the Christian faith.

Needham finds it so difficult to define reliably what we mean by belief that he seems almost tempted to abandon the word altogether. He does not do so, however, but points out that state­ments about belief need to be analysed within the framework of the different cultures, and a mastery of the local language, including its subtleties, is essential. For example, he says that the term kwoth for the spirit of the Nuer religion in Africa is very hard to understand. Needham goes on to say that 'Belief is not a discriminable experience, it does not constitute a natural resem­blance among men, and it does not belong to the "common behaviour of mankind.'" Thus, he argues, when one talks of the beliefs of other people, particularly in relation to non-Western religions, one has little idea of what is going on in their minds. I am not at all sure Needham is right, for all cultures have beliefs about causes, but whether there are similarities in different cul­tures as to their beliefs, and how they arise, is a central problem.

Another problem, as Needham points out, is how belief affects the behaviour of the individual. For example, a Saultaire Indian may endanger his life by believing a bear can understand what he is saying, and an Australian Aborigine believes that he will feel pain if a lock of his hair, taken away, is cut. How can such beliefs be reconciled with their experience? Belief is itself a word not always easily translated from one language to another.

The Shorter Oxford Dictionary gives two definitions of belief: 'The mental action, condition, or habit, of trusting to or con­fiding in a person or thing; trust, confidence, faith.' A second definition is 'Mental assent to or acceptance of a proposition, statement, or fact, as true, on the grounds of authority or evi­dence; the mental condition involved in this assent.' And for 'believe', 'To have confidence or faith in, and consequently rely upon.'

A key feature characterising something as a belief as dis­tinct from factual knowledge is how reliable the evidence is for the belief. But while evidence is a key word in relation to the validity of causal beliefs, it too presents severe problems of def­inition. How does one obtain reliable evidence? By authority? By direct observation? By science?

A distinctive feature of belief is that it may be graded true or false to varying degrees, depending on the evidence available, but it usually carries conviction. Unlike common knowledge, beliefs always have a true and false value - how right or wrong they are - regardless of whether or not the individual is aware of this. Reliable knowledge, by contrast, refers to what is clear­ly known - how to drive a car, for example, or that this is a page in a book, are facts. Probably the same could be said of all, well nearly all, of mathematics. There cannot be anyone who could dispute the validity of Euclid's planar geometry unless they were to totally abandon rationality. And as we shall see, much of science can be considered to be reliable knowledge.

But belief sometimes comes close to knowledge for the indi­vidual - for those, for example, who have seen ghosts, a belief in their existence becomes knowledge, though to others it is unbe­lievable. Knowledge provides us with a disposition to behave in a way that is constantly subject to modification - we know where we are when we are walking home — while belief is a disposition to behave in a manner that may be quite resistant to correction by experience - it is quite safe to drive after a few drinks./Beliefs can be very strong, with little reference to knowledge or evidence/ and it is often other people's beliefs that seem the most fallible.,

Beliefs are held about factors that have an important effect on our lives: why we get ill, what will happen when we die, how someone we love will respond, how to change things in our environment to our advantage. Memory can be viewed as a type of belief, not least because it can be unreliable. Indeed memory itself can be shaped by current beliefs. For example, in relationships, individuals' recall of important events, especially those involving some sort of conflict, can be greatly at variance.

A common characteristic of beliefs is that they explain the cause of an event, or how something will occur in the future. It is causal beliefs that are the main focus of this book since they have a particularly strong influence on human behaviour. Many beliefs guide the way a person chooses to behave. Belief in God can make a difference to a person's behaviour - that is almost a definition of a true belief, for if it did not influence how the person behaved, it would have no consequences and would be irrelevant. As the French philosopher Descartes put it: 'I needed in order to determine what people really believed to notice what they did rather than what they said.' David Hume also emphasised how beliefs affected our actions: 'Nei­ther man nor any other being ought ever be thought possest of any ability, unless it be exprest and put in action.' This fits very nicely with the view of the evolution of the brain in relation to action that I will propose.

In 1739, David Hume put forward his doctrine about causality. Our idea of causality, he claimed, is that there is a necessary connection among things, particularly actions. However, this connection cannot be directly observed, and can only be inferred from observing one event always following another. He thus argued that a causal relationship inferred from such observations could not in fact be rationally inferred. While this may be philosophically true, it is a problem for philosophers which need not concern us, as it is obvious what the cause is if, for example, I cut my hand with a knife.

David Premack, a psychologist, has pointed out that there are two classes of causal beliefs. One, as Hume suggested, is based on one event being linked to another, and can be called weak or 'arbitrary', for there need not be any obvious connec­tion between them, like switching on a light. Animals can learn connections by the pairing of events through this process of associative learning. The other, which is uniquely human, is strong or 'natural' causality, and is programmed into our brains so that we have evolved the ability to have a concept of forces acting on objects. Such strong causal beliefs are already present in human infants. A key question is how this type of belief evolved. Causal beliefs are a fundamental characteristic of humans; ani­mals, by contrast, as we shall see, have very few causal beliefs.

Beliefs come from a variety of sources that include the indi­vidual's experiences, the influence of authority, and the inter­pretation of events. At their core, beliefs establish a cause and effect relationship between events, and thus can be used as a guide to how one should behave in particular situations and how to judge the behaviour of others. From an evolutionary point of view, beliefs should help the individual survive, and I will argue that they had their origin in tool making and use. But beliefs are much wider in their nature, and often serve to make the person feel better by, for example, promoting self-esteem, and providing satisfactory explanations for events that are not well understood.

In the following chapters I will distinguish between several kinds of belief in relation to the topics they deal with. The dis­tinctions are not hard and fast, and the boundaries are often fuzzy. I will start with the acquisition of causal beliefs by children and then compare them to animals, and will argue that the latter rarely have causal beliefs. Then, considering tools, I will claim that the origin of human causal beliefs is related to tool use and manufacture. Once there were causal beliefs for tool use then our ancestors developed causal beliefs about all the key events in their lives, and I will examine the proposed mecha­nisms by which we now acquire our beliefs. False beliefs that result from abnormalities in the brain like confabulation and schizophrenia can provide insights into the way normal beliefs are formed. Religious beliefs that had their origin in attempts to account for crucial events in our ancestors' lives will be given special attention, together with the possibility of their being genetically programmed.

Then there are also paranormal beliefs like astrology and witchcraft, which vary across cultures, and for which evidence is rarely required. Beliefs about health, which are particularly important, also vary enormously, and are all too seldom based on proper evidence. Political and moral beliefs can determine how societies behave and include democracy, communism and racism. Scientific beliefs, which had their unique origins in Greece, have a special validity and are not personal but shared by the scientific community. A key question is: how similar or different are the belief processes involved. Finally, we may ask what sort of beliefs does the future hold?

I will be putting a big emphasis on the biological basis of belief, and also on evolutionary aspects of human behaviour. A very useful set of principles in relation to biological explanations was put forward by Niko Tinbergen, one of the founders of the sci­entific basis of behaviour in animals. He argued that behaviour can be explained in four separate but related ways: the physical cause, how it develops, its function, and its evolution. Consider, for example, hunger and sadness. The basic mechanisms, the physiological bases, are those that cause us to feel sad or hungry; how these develop - both in the embryo and after birth - is the second question; then there is their function and advantage to the individual: hunger to ensure eating, sadness to make up a loss; and finally, how did these behaviours evolve? It is such questions that we need to consider in relation to belief.

It may be helpful to briefly explain the role of genes in evolu­tion, in order to clarify what I mean when I refer to a particular character, even a belief, being genetically determined. Genes are unique in that they are the only elements in the cell that replicate, and thus can be passed to successive generations. The genes provide a programme for the development of the embryo by controlling how the cells in the embryo behave to give rise to the adult. Genes are basically boring and passive, as they do nothing but provide the code for making proteins, which are the true wizards of the cells. But they provide a programme for where and when particular proteins are made and so control, for example, how the cells of the brain connect with each other, and how one region of the brain connects with other regions. Thus, in evolution, changes in genes can result in changes in the form and behaviour of an organism; and depending on whether or not it is adaptive, that is, leads to better survival, that change in the genes will persist. That genes can determine behaviour is evident when one looks at the enormous variety of behaviours that animals are programmed to carry out, from sex to nest building.

Evolutionary psychology is based on the idea that in evolution the human brain acquired a number of specialised computation­al mechanisms - sometimes called modules - that determine emotion, reasoning, pattern seeking, and so on, and thus affect what we believe. The modules may not be physically separated in the brain, and there is considerable fluidity. Michael Shermer, who has thought deeply about these issues, considers modules like these to underlie what he calls the belief engine. There may be a causal operator in the brain that compels us to try and find out why things that matter to us happen. Without this impera­tive, we would not be successful in developing technology, on which we are so dependent.

An inability to find causes for important events and situa­tions leads to mental discomfort, even anxiety, so there is a strong tendency to make up a causal story to provide an expla­nation. Ignorance about important causes is intolerable. This also makes sense from an evolutionary perspective, as our ancestors needed to account for events rapidly even when they had little knowledge - delay could be a great disadvantage.

Belief has not, unfortunately, been the subject of much neuro-scientific research, and so the nature of the brain mechanisms that give rise to beliefs are poorly understood, though the study of mental illnesses that give rise to false beliefs may help. All this makes it difficult to know how the brain generates beliefs, as well as how to change people's beliefs - and as we all know, that can be very difficult.

One evolutionary approach to beliefs might make use of the meme, a concept introduced by Richard Dawkins in 1976. It refers to a unit of complex ideas, a unit of information that plays a role analogous to genes. Memes are memorable and can be likened to mind viruses. It is claimed that memes replicate and the selection of one meme over another may have no advantage to the individual in whose mind it rests. Since memes are claimed to have variation, heredity, and differential fitness, they could have the necessary properties for evolution by natural selection. Dawkins even claimed that we do not choose our memes, but that they choose us and manipulate us to their own ends. Just what a meme is, and how it is distin­guishable from beliefs, I find difficult. Is the word 'bird' a meme, and is the second law of thermodynamics also one? Apparently the song 'Happy Birthday to You' is a meme. There is no distinction made between memes relating to belief and knowledge. Moreover, no mechanism is proposed for the so-called replication of memes, or what they are selected for. Nevertheless, memes raise important questions on how social learning occurs, and why certain memes are so stable. Under­standing memes could help in understanding beliefs.

To understand the evolutionary origins of belief, it helps to understand what the brain is for. Belief is a property of the brain, which is made up of billions of nerve cells whose func­tion is totally dependent on the signals between them. But what is the primary function of the brain itself? I believe it has just one: to control bodily movements; and so this must be at the core of any attempt to understand belief. The evidence comes from the evolution of the brain.

Movement was present in our ancestral cells which gave rise to multicellular organisms some 3,000,000,000 years ago. They could move either by using flagella and cilia, whip-like struc­tures that are a bit like oars, or by amoeboid movement, the cells extending processes at their advancing end, and then pulling themselves forward to where these attach. This move­ment was a great advantage in finding food, dispersal to new sites, and escape from predators. A key point is that the protein molecules that produced these movements are the precursors of all muscle cells. Muscle-like cells are found in all animals, including primitive ones like hydra, a small freshwater creature with just two layers of cells arranged in the form of a tube, which uses the movement of its tentacles to capture prey.

In higher forms, like flatworms and molluscs, muscles are well developed and the ability to move is a characteristic of almost all animals. One only has to think of such forms as diverse as earthworms and squirrels. Again, this ability to move is fundamental to animal life - not just finding food and shelter, but the ability to escape from enemies. And this is where brains come from. The first evidence for brain-like precursors is the collection of nerves that are involved in controlling movement, like the crawling of earthworms or flatworms. Getting the mus­cles to contract in the right order was a very major evolutionary advance, and required the evolution of nerves themselves. Here we find the circuits of nerves that excite muscles in the right order: the precursors of brains.

The first advantage of the ability to move was most likely dis­persal and finding new habitats, but once the ability to move had evolved, it opened up new advantages such as finding food and avoiding danger. It became necessary to perceive the nature of the environment in order to decide when and where to move. There was a need for reliable senses. Light-sensitive cells are present among single-cell organisms so it is not too dif­ficult to imagine light coming to control movement. Then, later, came the eye. Of course there were other sensory systems that could detect touch, temperature and odours. All these had and have but one function, to provide information for the con­trol of movement. Emotions evolved to help animals make the appropriate motor movements like flight, attack, or sex. And that is why plants do not have brains. They are very successful but they do not need brains for they neither move significantly, or more importantly, exert forces on their environment in order to modify it for their own survival. No muscles, no brain.

There is no human or animal emotion that is not ultimately expressed as movement; in fact the argument is somewhat cir­cular, for what else is human behaviour? Sense organs have only one function, to help the organism decide how to move. Once the brain developed, it took on other functions such as those related to homeostasis, like hormonal release and tem­perature regulation. Our brain, with all its imagery and memo­ry, somehow enables us to decide how to behave, and it has only one ultimate function and that is to control bodily move­ments. The evolution of the brain that gave us beliefs is no more than an expansion of the original circuits that controlled movement in our ancient animal ancestors.

An internal representation of self arose in evolution from coordinating inner-body signals to produce appropriate behaviour. Increased accuracy and planning of movements was achieved by having mental models of the body in relation to the environment, and realising how these were causally related. Thus, when a stone falls on one's toe, one knows it, and one has to decide how to respond. More generally, as David Hume made clear, there is no experience of ‘self’ as something distinct from our body. Given that the main function of the brain is to control movement and to choose the appropriate movements for survival, it is not that unreasonable to suggest that belief arose in relation to tool use and manufacture, as both require a belief in causal interactions. This is a different view from that widely held, namely that the evolution of the human brain is related to social interactions. It will be helpful to look first at how human children acquire their causal beliefs, and then to compare them with those of animals.”

Contrary thinking -Chetan Parikh

In a book “Rediscovering the Wheel: Contrary Thinking and Investment Strategy’, the author, “Bradbury K. Thurlow, writes about the formulation of a contrary thinking strategy.

“If 95 per cent of all stock investors — amateur or professional — lose substantially relative to the general market over prolonged periods of time, they must be doing domething wrong. It follows that those who pursue a precisely contrary course of conduct will win (less commissions and taxes) actual profits equivalent to the losses suffered on the other side. When the amount of new money coming into the market is in balance with the supply of new issues coming to market, the odds on speculative and investment success, as measured by actual realized profits and losses, are essentially the same as those on betting on the red or black on a roulette wheel, with the brokers and the Government taking their cut as croupiers on every trade. What makes speculation more interesting than roulette is that a numerical majority of the players almost always bets on the wrong color.



The most primitive formulation of a contrary thinking stock-market strategy would be to keep tabs on what the small investor is thinking and doing and then study to think and do the opposite. If that were all there was to it this book could end right here, and this may be the most con­vincing explanation of why no one — to my knowledge — has yet written any kind of detailed study dealing with contrary thinking approaches: In earlier times, when the stock market was primarily influenced by emotional and uninformed small investors, every professional worth his salt knew enough to take the opposite side of the little fellow who was obviously acting foolishly. No one would bother to write — much less to read — a book telling one nothing more than that.



Fortunately or otherwise, the stock market during the 60s and 70s became enormously larger and more 'efficient' than it had ever been and its behavior is now primarily, almost exclusively, governed by the actions of highly sophisticated professionals handling portfolios worth hundreds of millions of dollars. These people are well paid, well trained, and well above average in intelligence. They are avaricious learners of facts and techniques, are supported by high priced staffs, and relish tough competition.



The fact remains that in the aggregate they make the same mistakes the amateur investing public used to make. The same small percentage do better than the market; the same high percentage buy at tops and sell at bottoms. Clearly knowledge and experience alone are not the major determinants of success in today's stock market.



After being mesmerized by this question for ten years, I wondered whether a possible explanation might not be found by using old and basic contrary thinking techniques, but gearing them up to match the complexity and sophistication of the present-day problems with which they must now deal.



In short, would it be possible to attack what is essentially a question of group behavior by building a disciplinary approach specifically designed to deal with behavioral problems? That seemed an obvious first step, but it immediately raised the question as to how much of the behavioral problem was individual psychology as we know it and how much was social — an area on which little of practical value seems to have been written.



I still do not know the proper mixture of ingredients and this book, consequently, presents a whole series of experimental mixtures designed to deal with specific aspects of the problem. These mixtures include both well-established psychological evidence and social evidence which must still be considered largely untested and hypothetical.



One of the most arbitrary and, I believed, significant assumptions to be included in this approach was to equate contrary thinking — which even in its simplest form is dialectic in nature, proceeding to synthetic conclusions by questions and answers that develop opposing points of view — with such so-called formal dialectic disciplines as have been developed under Marxism. For two and a half years I worked on a series of essays seeking to develop a non- or anti-Marxist 'individualist' dialectic that could be applied to extremely broad areas of human behavior. At the conclusion of that study I was satisfied that there was enough evidence to justify using the same methods in dealing with the full range of issues raised in making investment decisions.



In this context, one can define contrary thinking as a decision-making technique using dialectic methods at three distinct levels: 1) identification and criticism of a thesis, 2) exploration for tactical antitheses, and 3) development of a strategic synthesis.



The problem with definitions is that if they are concise and precise enough to satisfy those who made them, they may be thoroughly obscure to those to whom they are being explained. My definition uses terms from the German philosopher Hegel because they describe most accurately and efficiently what I want to say, but, except for these few words, one need not be a student of philosophy — let alone of Hegel — to understand contrary thinking.



A thesis, as here used, means an idea we are studying; the dialectic method is a way of pulling that idea apart by finding contradictions or inconsistencies in its various meanings. One of the best ways of finding the meanings of an idea is to look at all of its possible inferences from different subjective points of view and to test each by inquiring whether opposite interpretations could be equally valid.



Someone holds out a red flower and says: "This is a rose." Assuming he is not a liar, his statement is an assumption of fact and is not a thesis. A second person observes: "Yes, I know that, because roses are red." This is a thesis — a statement of belief. It is not necessarily a deliberate falsehood, but it is a conclusion based on the observation that the rose in question is red. Because the conclusion is based on observation, it is subject to cri­ticism. Using the dialectic method, one can examine the thesis by asking a number of questions: "Are all red flowers roses, or can there be other red flowers?" "Of course there are other red flowers, but this one is shaped like a rose." "Here is a flower of the same shape, but it is white. Does this mean it is not a rose?" "No, there are white roses as well as red roses." "Then you didn't know it was a rose because of its color alone, but because of its color and its shape. Isn't that right?"



This exchange is a primitive example of the method we have in mind. Its assumption is that the theses it examines are like the statement of the observer — partly true, partly false, based on inaccurate, incomplete, and undisciplined observation of more or less familiar experience. The anti­thesis, by showing that a flower could be red without being a rose, led to a revision of the original thesis: A rose is a rose because it is shaped like a rose. The observer knew that perfectly well to begin with, but had simply not thought his observation through.



In dealing with stock-market problems, experience has long shown that imperfect observation is not the exception, but the rule. Otherwise highly intelligent people are led to oversimplify observations when the data become too complex. Dr. Jerry Felsen, in his Cybernetic Approach to Stock Market Analysis (Exposition Press, NY, 1975) opines that it is difficult even for the most highly trained human mind to concentrate on more than four variables at a time.



What, then, does the investor do when faced with a barrage of facts and differing interpretations? He oversimplifies — his basic concepts, his interpretations, the data he is willing to consider, his analytical tools, everything that goes into his decision-making process. He then wonders why he makes so many wrong decisions.



How many of us have bought a stock because we thought the market was going up? Is this not as weak a thesis as saying a rose is a rose because it is red? Like the rose thesis, it may be supported by subconscious knowledge that gives it validity, but how does one know until one asks the right questions? The thesis could be equally based on what one had for breakfast that morning, with no rational foundation whatever.



Contrary thinking does not solve the information problem by enabling us to cope with more variables, but it does, by allowing us to examine the problems and the approaches to them in different lights, help us to avoid waste motion and to concentrate our efforts in the areas we pick out for ourselves as being most profitable to study. Our judgment will still be faulty, but if we continue to identify and criticize the theses we are using, we should, in the slow learning process, come to eliminate some, improve others, and discover new ones more suitable to work with.



If we are engaged in any form of selling activity (Who is not, at one time or another?) we are taught from our earliest days to think positively. Seeing the good in people and ideas is in the best interests of society and makes us socially attractive to others; moreover, it is a natural human instinct that increases our enjoyment of life.



The problem that comes up in dealing in any marketplace where assets are freely exchanged is that our natural goodwill toward man may prevent us from recognizing that some assets are increasing in value while others are declining. Owners of deteriorating assets will rationally try to exchange them for assets that are appreciating; to do this they must find takers. To find takers they must make the assets attractive, either by lowering their price or by emphasizing their good qualities and obscuring their defects. At the same time they will resist as far as possible paying high prices for ap­preciating assets and will, as bargainers, emphasize their defects and obscure their good qualities.



These attitudes are basic to all trading operations, be it horses or blue-chip securities. The person of goodwill will be impressed by the commendations of others and will tend to underestimate the value of what he owns if no one else is praising it; socially he will be inclined to exchange his good assets for assets of lower quality. He is the dupe of the marketplace, the born speculative loser.



Contrary thinking, without attempting to change the morals of the marketplace — which have been the same for millennia — enables one to recognize them for what they are and to counteract the destructive effects of indiscriminate goodwill through the antidote of rational negative thinking.



To arrive at constructive conclusions contrary criticism begins destruc­tively, negatively. Its method is to find the weaknesses in an idea and attack them with gusto. If the trunk of the idea can survive the pruning, new branches may grow or can be grafted on; if it does not survive, it is just so much dead wood.



One of the most concrete and practical forms of stock-market ideas or theses are our approaches to the raw data of the market­place. There is so much material available that we must spend a con­siderable effort determining which parts of it are useless and a waste of time to study. This determination will rest in part, of course, on the total amount of time we have available; the professional can, and should, absorb a good deal more information than the part-time amateur.



The amounts are so overwhelming, however, that everyone must be ruthlessly selective. In practice we must work through and from the digests of others: the summary studies of specialists, the theoretical interpretations of generalists, the background reports of news and economic analysts, and the interpretations of market psychologists.



Every piece of information that is interpreted by others before it reaches us is subject to distortion. Tolkien called it subcreativity — the process by which we arrange all the data we receive subjectively in our own minds. By applying criticism to our sources we come to recognize these distortions and factor them out. Some are individual and are learned only after long ac­quaintance; others are institutionalized: brokers' reports are usually too optimistic, technicians tend to be dogmatic, economists do not like to stray from the consensus, newsmen emphasize the ephemeral and miss the main story, almost everyone is uncomfortable and timid in dealing with psy­chology — except those who do not know what they are talking about — and so it goes.



There is a good deal of contrary criticism in this book. Much of it is bla­tantly destructive and directed against institutions in the financial communi­ty that are almost as sacred as motherhood. Its sole purpose is to suggest how the hard-pressed investor can avoid wasting valuable time. The occa­sional constructive criticisms represent syntheses in the dialectic process and suggest how some of the expertise in the investment world might be put to more useful purposes.



Moving from criticism to the second activity of contrary thinking — exploration for tactical antitheses — brings us into a sort of game that can have all the pleasures of individual competition. The tactical antithesis is based on the assumption that a given thesis is wrong and that going opposite to it, as in the example given at the beginning of this chapter, can be profitable.



Finding and exploiting tactical antitheses has been developed into a whole investment discipline by Humphrey Neill in his Theory of Contrary Opinion — which I shall discuss at some length in later chapters. I perhaps do not do my old friend justice in using the adjective tactical. Contrary Opinion Theory is as good a method as has ever been developed for sensing major stock-market turning points, and, lacking every other ability, the investor who can do that with any degree of success should be well on his way to a brilliant future.



Most of the time, however, the opportunities to identify a major turning point will occur only rarely and will be of fairly short duration. For this reason, although the theory fits in admirably with a larger investment strategy, it is essentially tactical in nature: a means for timing purchases and sales under certain special conditions.



Strategy is the most difficult of investment concepts and by definition, is eclectic; it takes in everything it can use and at the same time keep under control. Contrary thinking, by itself, is neither a synthesis nor a strategy, but it is both synthetic and strategic in its problem-solving approach. As an exercise in disciplined skepticism it pushes the mind toward disbelief while restraining it this side of inactivity; the only purpose of the decision- making process, after all, is to make decisions.



If this constant criticism, exploration, and balancing of positive and nega­tive ideas does not come naturally to the stock-market investor, it is perhaps a good idea to remind ourselves, when we find contrary thinking most irritating, that our natural inclination, nineteen times out of twenty, will lead us to the wrong stock-market choice. The statistical odds at any given moment may be 50-50 that a stock will move either way, but as members of a crowd — even if we have no physical contact with its other members — we are susceptible subconsciously to all the influences by which crowds are swayed. Statistical probabilities would rank low in any such list.



This means that to recognize contrary thinking as a useful tool is only a first step toward learning to use it effectively. As a discipline it, like giving up tobacco, requires practice day after day. The critical part comes easily enough to us if we constantly keep in mind that we do not want to throw the baby out with the bath water. The discipline in criticism comes in salvaging and rehabilitating what is left after our attacks have done their worst.



The tactical exercises are a kind of game. In practicing them at random we shall find in a good many instances that the thesis we attack turns out to be right, or that if we are right in judging it wrong we may choose the wrong alternative to it. To many questions there will only be one right answer and a thousand wrong ones.



Arriving at a synthesis involves making many revisions as one proceeds. In a field as dynamic as investments, where ideas bloom like cactus flowers that live only a few hours after months of preparation, the revision process does not stop when the basic strategy has been worked out. Most of the time, that will only be the beginning.



Contrary thinking is a deliberate shaking of the mind back and forth, reversing and reaffirming plausible views to separate out the non-essential much as the gold panner shakes out unwanted pebbles. It is worth the effort because it frees the mind of at least certain kinds of misconceptions that show their inconsistencies under dialectic analysis.



The most important and persistent of these misconceptions, as I see it, are based on the 'historical' assumption that a knowledge of the past enables one to predict the future. A mathematician will immediately spot the weak­ness in this proposition by the lack of precision with which we usually define knowledge of past human behavior. Richelieu, who may have been the most able strategist since Julius and Augustus Caesar, once remarked that "The past bears no reference to the present; the relationship between times, places, and persons is always an entirely different one."



I do not believe the great Cardinal was depreciating his own deep under­standing of history and human behavior, but rather observing that know­ledge of these things was worthless without dialectic analysis to determine and discard the non-essentials. Stock-market investment and speculation under modern conditions is a game closely resembling the politics and diplo­macy of an era when the best minds were intent on family greatness and national power. Accepting Richelieu's antithesis to the thesis that historical knowledge is valuable, one can dialectically arrive at the synthesis that the past can frequently be the most instructive to us when it seems to have the least superficial resemblance to the present. Human nature, after all, does not change and native intelligence does not improve.



The foregoing exercise in contrary thinking is only a little more sophisti­cated than our earlier primitive discussion of the rose and is probably about as complicated intellectually as contrary thinking is likely to be. The purpose of dialectics is not to make things difficult, but to reduce them to the simplest possible terms. Obviously one antithesis or synthesis does not exclude any number of other possibilities. We choose what appeals to us subjectively and build from there.



But isn't this the exact opposite of a discipline? By admitting a totally subjective choice, what claim do we then have of keeping our objectivity?



One answer to this dilemma is that if we do not make our choice sub­jectively, it will be imposed on us from outside and will simply be someone else's subjective choice passed on to us by suggestion which we shall have accepted without considering the alternatives. All decisions are subjective, whether we make them ourselves or submit to having them made for us. The discipline in contrary thinking consists in processing the pros and cons through our minds so that we have at least been through the exercise of' hearing both sides of the case' before taking action.



In practice one will find that the deliberate suspension of judgment until a decision must be made goes contrary to our natural vanity and becomes habitual only after long discipline. Dialectical analysis, which is only another name for contrary thinking, deliberately puts roadblocks in the way of ideas we receive to protect us against making hasty decisions — which have a better than even chance of also being unwise decisions.”

Inverted reasoning and its consequences

In a classic, “ An Investor’s Anthology”, there is a brilliant piece by George Selden written in 1912.

“It is hard for the average man to oppose what appears to be the general drift of public opinion. In the stock market this is perhaps harder than elsewhere; for we all realize that the prices of stocks must, in the long run, be controlled by public opinion. The point we fail to remember is that public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horsepower of the markets—the mere number of men does not signify.

This is why the great body of opinion appears to be bullish at the top and bearish at the bottom. The multitude of small traders must be, as a plain necessity, long when prices are at the top, and short or out of the market at the bottom. The very fact that they are long at the top shows that they have been supplied with stocks from some source.

Again, the man with one million dollars is a silent individual. The time when it was necessary for him to talk is past—his money now does the talking. But the one thousand men who have one thousand dollars each are conversational, fluent, verbose to the last degree.

It will be observed that the above course of reasoning leads up to the conclusion that most of those who talk about the market are more likely to be wrong than right, at least so far as speculative fluctuations are concerned. This is not complimentary to the “moulders of public opinion,” but most seasoned newspaper reader will agree that it is true. The daily press reflects, in a general way, the thoughts of the multitude, and in the stock market the multitude is necessarily, as a logical deduction from the facts of the case, likely to be bullish at high prices and bearish at low.

It has often been remarked that the average man is an optimist regarding his own enterprises and a pessimist regarding those of others. Certainly this is true of the professional trader in stocks. As a result of the reasoning outlined above, he come habitually to expect that nearly every one else will be wrong, but is, as a rule, confident that his own analysis of the situation will prove correct. He values the opinion of a few persons who he believes to be generally successful; but aside from these few, the greater the number of the bullish opinions he hears, the more doubtful he becomes about the wisdom of following the bull side.

This apparent contrariness of the market, although easily understood when its causes are analyzed, breeds in professional traders a peculiar sort of skepticism—leads them always to distrust the obvious and to apply a kind of inverted reasoning to almost all stock market problems. Often, in the minds of traders who are not naturally logical, this inverted reasoning assumes the most erratic and grotesque forms, and it accounts for many apparently absurd fluctuations in prices which are commonly charged to manipulation.

For example, a trader starts with this assumption: The market has had a good advance; all the small traders are bullish; somebody must have sold them stock which they are carrying; hence the big capitalists are probably sold out or short and ready for a reaction or perhaps for a bear market. Then if a strong item of bullish news comes out—one, let us say, that really makes an important change in the situation—he says, “Ah, so this is what they have been bulling the market on! It has been discounted by the previous rise.” Or he may say, “They are putting out this bull news to sell stocks on.” He proceeds to sell out any long stocks he may have or perhaps to sell short.

His reasoning may be correct or it may not; but at any rate his selling and that of others who reason in a similar way is likely to produce at least a temporary decline on the announcement of the good news. This decline looks absurd to the outsider and he falls back on the old explanation “All manipulation.”

The same principle is often carried further. You will find professional traders reasoning that favorable figures on the steel industry, for example, have been concocted to enable insiders to sell their steel; or that gloomy reports are put in circulation to facilitate accumulation. Hence they may act in direct opposition to the news and carry the market with them, for the time at least.

The less the trader knows about the fundamentals of the financial situation the more likely he is to be led astray in conclusions of this character. If he has confidence in the general strength of conditions, he may be ready to accept as genuine and natural a piece of news which he would otherwise receive with cynical skepticism and use as a basis for short sales. If he knows that fundamental conditions are unsound, he will not be so likely to interpret bad news as issued to assist in accumulation of stocks.

The same reasoning is applied to large purchases through brokers known to be associated with capitalists. In fact, in this case we often hear a double inversion, as it were. Such buying may impress the observer in three ways:

1. The “rank outsider” takes it a face value, as bullish.
2. A more experienced trader may say, “If they really wished to get the stocks they would not buy through their own brokers, but would endeavor to conceal their buying by scattering it among other houses.”
3. A still more suspicious professional may turn another mental somersault and say, “They are buying through their own brokers so as to throw us off the scent and make us think someone else is using their brokers as a blind.” By this double somersault such a trader arrives at the same conclusion as the outsider.

The reasoning of traders becomes even more complicated when large buying or selling is done openly by a big professional who is know to trade in and out for small profits. If he buys 50,000 shares, other traders are quite willing to sell to him and their opinion of the market is little influenced, simply because they know he may sell 50,000 the next day or even the next hour. For this reason great capitalists sometimes buy or sell through such big professional traders in order to execute their orders easily and without arousing suspicion. Hence the play of subtle intellects around big trading of this kind often becomes very elaborate.

It is to be noticed that this inverted reasoning is useful chiefly at the top or bottom of a movement, when distribution or accumulation is taking place on a large scale. A market which repeatedly refuses to respond to good news after a considerable advance is likely to be “full of stocks.” Likewise a market which will not go down on bad news is usually “bare of stock.”

Between the extremes will be found long stretches in which capitalists have very little cause to conceal their position. Having accumulated their lines as low as possible, they are then willing to be known as the leaders of the upward movement and have every reason to be perfectly open in their buying. This condition continues until they are ready to sell. Likewise, having sold as much as they desire, they have no reason to conceal their position further, even though a subsequent decline may run for months or a year.

It is during a long upward movement that the “lamb” makes money, because he accepts facts as facts, while the professional trader is often found fighting the advance and losing heavily because of the overdevelopment of cynicism and suspicion.

The successful trader eventually learns when to invert his natural mental processes and when to leave them in their usual position. Often he develops a sort of instinct which could scarcely be reduced to cold print. But in the hands of the tyro this form of reasoning is exceedingly dangerous, because it permits of putting an alternate construction on any event. Bull news either (1) is significant of a rising trend of prices, or (2) indicates that “they” are trying to make a market to sell on. Bad news may indicate either a genuinely bearish situation or a desire to accumulate stocks at low prices.

The inexperienced operator is therefore left very much at sea. He is playing with the professional’s edged tools and is likely to cut himself. Of what use is it for him to try to apply his reason to stock market conditions when every event may be doubly interpreted?

Indeed, it is doubtful if the professional’s distrust of the obvious is of must benefit to him in the long run. Most of us have met those deplorable mental wrecks, often found among the “chairwarmers” in brokers’ offices, whose thinking machinery seems to have become permanently demoralized as result of continued acrobatics. They are always seeking an “ulterior motive” is everything. They credit—or debit—Morgan and Rockefeller with the smallest and meanest trickery and ascribe to them the most awful duplicity in matters which those “high financiers” would not stoop to notice. The continual reversal of the mental engine sometimes deranges its mechanism.

Probably no better general rule can be laid down than the brief one, “Stick to common sense.” Maintain a balanced, receptive mind and avoid abstruse deductions. A few further suggestions may, however, be offered:

If you already have a position in the market, do not attempt to bolster up your failing faith by resorting to intellectual subtleties in the interpretation of obvious facts. If you are long or short of the market, you are not an unprejudiced judge, and you will be greatly tempted to put such an interpretation upon current events as will coincide with your preconceived opinion. It is hardly too much to say that this is the greatest obstacle to success. The least you can do is to avoid inverted reasoning in support of your own position.

After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated. Be suspicious of bull news at high prices, and of bear news at low prices.

Bear in mind that an item of news usually causes but one considerable movement of prices. If the movement takes place before the news comes out, as a result of rumors and expectations, then it is not likely to be repeated after the announcement is made; but if the movement of prices has not preceded, then the news contributes to the general strength or weakness of the situation and a movement of prices may follow.

CONFUSING THE PRESENT WITH

THE FUTURE-DISCOUNTING

It is axiomatic that inexperienced traders and investors, and indeed a majority of the more experienced as well, are continually trying to speculate on past events. Suppose, for example, railroad earnings as published are showing constant large increases in net. The novice reasons, “Increased earnings mean increased amounts applicable to the payment of dividends. Prices should rise. I will buy.”

Not at all. He should say, “Prices have risen to the extent represented by these increased earnings, unless this effect has been counterbalanced by other considerations. Now what next?”

It is a sort of automatic assumption of the human mind that present conditions will continue, and our whole scheme of life is necessarily based to a great degree on this assumption. When the price of wheat is high farmers increase their acreage because wheat-growing pays better; when it is low they plant less. I remember talking with a potato-raiser the above custom. When potatoes were low he had planted liberally; when high he had cut down his acreage—because he reasoned that other farmers would do just the opposite.

The average man is not blessed—or cursed, however you may look at it—with an analytical mind. We see “as through a glass darkly.” Our ideas are always enveloped in a haze and our reasoning powers work in a rut from which we find it painful if not impossible to escape. Many of our emotions and some of our acts are merely automatic responses to external stimuli. Wonderful as is the development of the human brain, it originated as an enlarged ganglion, and its first response is still practically that of the ganglion.

A simple illustration of this is found in the enmity we all feel toward the alarm clock which arouses us in the morning. We have carefully set and wound that alarm and if it failed to go off it would perhaps put us to serious inconvenience; yet we reward the faithful clock with anathemas.

When a subway train is delayed nine-tenths of the people waiting on the platform are anxiously craning their necks to see if it is coming, while many persons on it who are in danger of missing an engagement are holding themselves tense, apparently in the effort to help the train along. As a rule we apply more well-meant, but to a great extent ineffective, energy, physical or nervous, to the accomplishment of an object, than to analysis or calculation.

When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and out ignorance of it. From reading, observation and conversation we imbibe a miscellaneous assortment of ideas from which we conclude that the situation is bullish or bearish. The very form of the expression “the situation is bullish”—not “the situation will soon become bullish”—shows the extent to which we allow the present to obscure the future in the formation of our judgment.

Catch any trader and pin him down to it and he will readily admit that the logical moment for the highest prices is when the news after it comes out—if not at the moment, at any rate “on a reaction.”

Most coming events cast their shadows before, and it is on this that intelligent speculation must be based. The movement of prices in anticipation of such an event is called “discounting,” and this process of discounting is worthy of a little careful examination.

The first point to be borne in mind is that some events cannot be discounted, even by the supposed omniscience of the great banking interests—which is, in point of fact, more than half imaginary. The San Francisco earthquake is the standard example of an event which could not be foreseen and therefore could not be discounted; but an event does not have to be purely an “act of God” to be undiscountable. There can be no question that our great bankers have been as much in the dark in regard to some recent Supreme Court decisions as the smallest “piker” in the customer’s room of an odd-lot brokerage house.

If the effect of an event does not make itself felt before the event takes place, it must come after. In all discussion of discounting we must bear this fact in mind in order that our subject may not run away with us.

On the other hand, an event may sometimes be over-discounted. If the dividend rate on a stock is to be raised from four to five per cent, earnest bulls, with an eye to their own commitments, may spread rumors of six or seven per cent, so that the actual declaration of five per cent may be received as disappointing and cause a decline.

Generally speaking, every event which is under the control of capitalists associated with the property, or any financial condition which is subject to the management of combined banking interests, is likely to be pretty thoroughly discounted before it occurs. There is rarely any lack of capital to take advantage of a sure thing, even though it may be known in advance to only a few persons.

The extent to which future business conditions are known to “insiders” is, however, usually overestimated. So much depends, especially in America, upon the size of the crops, the temper of the people, and the policies adopted by leading politicians, that the future of business becomes a very complicated problem. No power can drive the American people. Any control over their action had to be exercised by cajolery or by devious and circuitous methods.

Moreover, public opinion is becoming more volatile and changeable year to year, owing to the quicker spread of information and the rapid multiplication of the reading public. One can easily imagine that some of our older financiers must be saying to themselves. “If I only had my present capital in 1870, or else had the conditions of 1870 to work on today!”

A fair idea of when the discounting process will be completed may usually be formed by studying conditions from every angle. The great question is, when will the buying or selling become most general and urgent? In 1970, for example, the safest and best time to buy the sound dividend-paying stocks was on the Monday following the bank statement with showed the greatest decrease in reserves. The market opened down several points under pressure of liquidation, and many standard issues never sold so low afterward. The simple explanation was that conditions had become so bad that they could not get any worse without utter ruin, which all parties must and did unite to prevent.

Likewise in the Presidential campaign of 1900, the lowest prices were made on Bryan’s nomination. Investors said at once, “He can’t be elected.” Therefore his nomination was the worst that could happen—the point of time where the political news became most intensely bearish. As the campaign developed his defeat became more and more certain, and prices continued to rise in accordance with the general economic and financial conditions of the period.

It is not the discounting of an event thus known in advance to capitalists that presents the greatest difficulties, but cases where considerable uncertainty exists, so that even the clearest mind and the most accurate information can result only in a balancing of probabilities, with the scale perhaps inclined to a greater or less degree in one direction or the other.

In some cases the uncertainty which precedes such an event is more depressing than the worst that can happen afterward. An example is a Supreme Court decision upon a previously undetermined public policy which has kept business men so much in the dark that they feared to go ahead with any important plans. This was the case at the time of the Northern Securities decision in 1904. “Big business” could easily enough adjust itself to either result. It was the uncertainty that was bearish. Hence the decision was practically discounted in advance, no matter what it might prove to be.

This was not true to the same extent of the Standard Oil and American Tobacco decisions of 1911, because those decisions were an earnest of more trouble to come. The decisions were greeted by a temporary spurt of activity, based on the theory that the removal of uncertainty was the important thing; but a sensational decline started soon after and was not checked until the announcement that the Government would prosecute the United States Steel Corporation. This was deemed the worst that could happen for some time to come, and was followed by a considerable advance.

More commonly, when an event is uncertain the market estimates the chances with considerable nicety. Each trader backs his own opinion, strongly if he feels confident, moderately if he still has a few doubts which he cannot down. The result of these opposing views may be stationary prices, or a market fluctuating nervously within a narrow range, or a movement in either direction, greater or smaller in proportion to the more or less emphatic preponderance of the buying or selling.

Of course it must always be remembered that it is dollars that count, not eh number of buyers or sellers. A few great capitalists having advance information which they regard as accurate may more than counterbalance thousands of small traders who hold an opposite opinion. In fact, this is the condition very frequently seen.

Even the operations of an individual investor usually have an effect on prices pretty accurately adjusted to his opinions. When be believes prices are low and everything favors an upward movement, he will strain his resources in order to accumulate as heavy a load of securities as he can carry. After a fair advance, if he sees the development of some factor which might cause a decline—though he doesn’t really believe it will—he thinks it wise to lighten his load somewhat and make sure of some of his accumulated profits. Later when he feels that prices are “high enough,” he is a liberal seller; and if some danger appears while the level of quoted values continues high, he “cleans house,” to be ready for whatever may come. Then if what he considers an unwarranted speculation carries prices still higher, he is very likely to sell a few hundred shares short by way of occupying his capital and his mind.

It is, however, the variation of opinion among different men that has the largest influence in making the market responsive to changing conditions. A development which causes one trader to lighten his line of stocks may be regarded as harmless or even beneficial by another, so that he maintains his position or perhaps buys more. Out of a worldwide mixture of varying ideas, personalities and information emerges the average level of prices—the true index number of investment conditions.

The necessary result of the above line of reasoning is that not only probabilities but even rather remote possibilities are reflected in the market. Hardly any event can happen of sufficient importance to attract general attention which some other process of reasoning cannot construe our old friend of the news columns to the effect that “the necessary a large volume of business,” may influence some red-blooded optimist to buy 100 Union, but the grouchy pessimist who has eaten too many doughnuts for breakfast will accept the statement as an evidence of the scarcity of real bull news and will likely enough sell 100 Union short on the strength of it.

It is overextended speculator who causes most of the fluctuations that look absurd to the sober observer. It does not take much to make a man buy when he is short of stocks “up to his neck.” A bit of news which he would regard as insignificant at any other time will then assume an exaggerated importance in his eyes. His fears increase in geometrical proportion to the size of his line of stocks. Likewise the overloaded bull may begin to “throw his stocks” on some absurd story of a war between Honduras and Roumania [sic], without even stopping to look up the geographical location of the countries involved.

Fluctuations based on absurdities are always relatively small. They are due to an exaggerated fear of what “the other fellow” may do. Personally, you do not fear a war between Honduras and Roumania; but may not the rumor be seized upon by the bears as an excuse for a raid? And you have too many stocks to be comfortable if such a break should occur. Moreover, even if the bears do not raid the market, will there not be a considerable number of persons who, like yourself, will fear such a raid, and will therefore lighten their load of stocks, thus causing some decline?

The professional trader, following this line of reasoning to the limit, eventually comes to base all his operations for short turns in the market not on the facts but on what he believes that facts will cause others to do—or more accurately, perhaps, on what he sees that the news is causing others to do; for such a trader is likely to keep his fingers constantly on the pulse of buying and selling as it throbs on the floor of the Exchange or as recorded on the tape.

The non-professional, however, will do well not to let his mind stray too far into the unknown territory of what others may do. Like the “They” theory of values, it is dangerous ground in that it leads toward the abdication of common sense; and after all, other may not prove to be such fools as we think they are. While the market is likely to discount even a possibility, the chances are very much against out being able to discount the possibility profitably.

In this matter of discounting, as in connection with most other stock market phenomena, the most useful hint that can be given is to avoid all efforts to reduce the movement of prices of rules, measures, or similarities and to analyze each case by itself. Historical parallels are likely to be misleading. Every situation is new, though usually composed of familiar elements. Each element must be weighed by itself and the probable result of the combination estimated. In most cases the problem is by no means impossible, but the student must learn to look into the future and to consider the present only as a guide to the future. Extreme prices will come at the time when the news is most emphatic and most widely disseminated. When the point is passed the question must always be, “What next?””