Do You Think Like A Zebra In Markets?
The problems posed by the Narrative Bias are exacerbated by our human tendency to go emotionally “all in” on something – we either fully like it, or fully dislike it.
This is known as the halo effect, and leads to black and white thinking that can be counterproductive to traders.
15. Halo Effect
The halo effect stems from our emotional reaction to our surroundings, and colors our perception and judgments accordingly.
Celebrities provide a good illustration of this, where people tend to have favorable opinions, or tend to attribute positive traits to them, simply because of their physical appearance.
If you think about it, it isn’t difficult to come to the realization that this makes no logical sense, since very few of a celebrity’s fans actually know the celebrity personally – their rose-tinted view of the celebrity is colored by the halo effect.
The same thing happens with politicians, where supporters tend to fixate on favorable first impressions. If someone thinks that a politician’s physical appearance is attractive, the halo effect kicks in and everything the politician says or does is always thought of in positive terms.
However, it doesn’t always have to be about physical appearance.
If something a politician says at a rally evokes a strong emotional reaction from the audience, the halo effect can also kick in and cause them to view the politician more favorably.
This naturally leads to the polarization of opinion, with those who agree with the politician giving their fervent support, and those who do not, their complete disapproval.
The political climate in America today is an excellent demonstration of this “us and them” thinking – which is a hallmark of the halo effect.
The same polarized thinking also occurs in financial markets, and is most easily observed in how they coalesce around financial “gurus” and the narratives they espouse.
Good examples of this include diehard goldbugs and crypto evangelists who refuse to consider opposing viewpoints – to them, they are “right”, and everyone else is “wrong”.
Needless to say, this is fertile ground for the confirmation bias to take root, which is exactly what happens, with the resulting formation of ideological echo chambers.
A more nuanced way of thinking, and one more reflective of how the world works, is to consider the circumstances with which a particular narrative can work, and the circumstances with which it cannot.
For example, cryptocurrencies are not an uncorrelated asset, but, depending on the point in time, can be a more effective inflation hedge than gold. This certainly turns the conventional narrative of gold being the go-to inflation hedge on its head, while also disputing the claim that cryptos are good portfolio diversifiers.
Who knows how this will change in the future?
Getting sucked into the halo effect is to fail to acknowledge that market conditions, and the relationship between market and economic variables, are always in flux.
If a trader or investor only ever sees one point of view, he will only ever position himself in one direction.
A goldbug will only ever be long gold, and a crypto hodler will only ever be long crypto – often with disastrous results when market conditions change for the worse!
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