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Gerard Moore 25 / May / 21

Mirror neurons and crowds of stocks - how science is getting more popular


Mirror neurons and stock crowds
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The stock market is a reflection of the "real" world under a magnifying glass. Due to higher speeds and the absence of any restrictions on self-expression, in addition to the size of capital, all the characteristic features of a person as an individual are visible. And at the level of markets for humanity as a species.

Why is psychology so important to investing? This is a filter or lens through which all information that comes to us from the surrounding world is refracted. This is true for everyday life, but it is especially true in the stock market, which is essentially pure information, devoid of any "objective" characteristics. Also, the market often shows properties whose meaning is not obvious or the opposite of the norm. For example, in the “real” world, looking at a house, you and I will most likely agree that this is a house, and not something else. This is a universal truth that is understood by those who grew up in modern society.

There are no "houses" in the stock market - there is only endless room for interpretation. But this does not mean that a person is not trying to try on filters familiar to the "real" world, including the emotional one. Simply put, many investors (and professionals) come to the market with crowd psychology. How is it formed?

Hundreds of thousands of years ago, the ancestors of man did not have verbal means of communication - language did not exist in its modern form! But the need for early warning of dangers and opportunities was very pronounced. Any predator was a fatal threat to a person who had neither claws nor sharp teeth. The human response was a higher than in most other species, the ability to organize - to form hunting and fighting units, tribes and other social structures, which became the prototypes of the world in which we live now. This, in turn, led to the emergence of new questions - the transmission of not only alerts, but also skills that a person was rapidly beginning to form.

As mentioned above, language did not exist at the dawn of civilization - it developed not before, but in parallel with the formation of man. Mirror neurons became the advantage of our species, thanks to which people were able not only to quickly adopt each other's emotional state, but also to repeat actions. Thus, the effectiveness of protection from predators, collective hunting and all other aspects of human activity has increased significantly. The bottom line is the top of the food chain. In the course of this ascent, the human brain has developed many semi-automatic ways of responding to information that have stayed with us today in this century.

I think that now it is clear which part of our psyche, but also organics, is responsible for inflating, for example, bubbles (everyone buys and rejoices, and I buy), or for sharp collapses in the market (everyone sells, and I sell). But there is a difference: the market is not a hunting party, and not even a tribe, but a collection of all participants from all over the world, organized and not very organized, as well as their computers. That is, in fact, this is all economically active humanity at once. Difference in scale - a new trend is created by the collective actions of a relatively small number of participants with a disproportionately large amount of capital (smart money and, more recently, the US Central Bank), while all the others only participate in the inertia that is formed by this impulse (trend).

Very often, due to the lack of competence in the immediate environment of the investor to detect this trend and its development, another law of the human psyche comes into force - inertia, which we will talk about in more detail later. In practice, many buy shortly before the tops, and sell at a loss or lock up capital in sagging instruments, which leads to losses not only due to drawdowns, but also due to capital idleness instead of being used in actual instruments.

The information lags behind the price movement. As a result, many investors become the very members of the tribe who jumped up last when the tiger approached. And because of the disproportionate distribution of capital among the participants, most retail investors and small organizations very often become such a lagging "minority".

While not new, the recent story of GameStop (NYSE: GME) stock is a great example of how mirror neurons work in collective investment, because it shows the mechanics of what is happening in miniature. The initiators of the campaign acted as smart money (major participants) - they accumulated the first positions in the paper before its explosive growth. Not having enough capital to "move" the price of the paper, they mobilized the purchasing power of their Internet community and together drove the "mammoths" from hedge funds up to cover short positions. Historical analogies are more than appropriate - the hunt was successful. On the other hand, there were and are many who came to this story late and ended up overboard.

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