Monday, August 25, 2008

The New Contrarian Investment Strategy: Chp 4: The Strange World of Reality

In this chapter, Dreman references academic research that supports the idea that individuals gravitate towards crowd thinking under stressful or uncertain situations. When uncertainty is present, people also tend to abandon objective reasoning and look towards authoritative and so called expert opinions. The stock market is shrouded in uncertainty and for this reason people often look to expert opinions. Dreman has already demonstrated in previous chapters the dismal track record of many so-called market experts.

Crowd thinking is dominated by images. The image must be simple and compelling such as the frequently courted image of "instant wealth". These images can swiftly change.

Dreman explains several of the market bubbles that have occurred in history. It's fascinating to observe that people make the same mistakes over and over again particularly with the stock market. This demonstrates the prevalence and power of group thinking in the market.

A student of market history, Dreman observers that all manias have surprisingly similar characteristics. Each mania has sound beginnings but is based on a simple idea. The demonstration of quick riches demonstrated by early participants in a bubble leads to more feverish buying and initially a self-fulfilling prophecy as more participants buy into the image of instant wealth. Crowd thinking blinds most people to the dangers of the bubble. The opinions converge as a consensus opinion is formed and facts are ignored. Then at some point, the image changes and anxiety replaces the enthusiasm and overconfidence in the market bubble. At that point, panic breaks out and the bubble breaks. Lastly, we as investors (in general) do not learn from these past mistakes because each market bubble is believed to be different than the last one.

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