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Teller’s list of some of the essential characteristics of a magician’s craft reads like a cautionary tale to investors. Here are his points, with a little of my own interpretation of how they apply to better understanding economic analysis and capital markets behavior. His list is represented, verbatim, in bold. Everything else is my own interpretation unless otherwise stated.
#1 - Exploit pattern recognition.
There is a reason why magicians use playing cards in so many tricks. We all know the number of cards in a deck, the numbers and face cards involved, and so forth. So when something unexpected occurs, it seems surprising because we thought knew the pattern (52 cards, 4 suits, etc) and understood the odds of say, the magician guessing “Our card” from the seemingly random collection at hand.
How many times have your heard “This company has a razor/razor blade business model?” Or, “The stock market usually rallies in the fourth year of a presidential election cycle?” Humans are simply desperate for patterns to emerge in their lives. With so much going on, life would be a lot simpler if events could follow some repeatable form. So we look for them, even in complex environments such as global business model analysis or capital markets pricing behavior. And we are as surprised as when we’ve seen a great magic act when they don’t follow our preconceived notions of a repeatable pattern.
#2 - Make the secret a lot more trouble than the trick seems worth.
In the Smithsonian article Teller relays a story of how he and Penn pulled 500 roaches out of a hat on the Letterman show. The stunt took months to prepare and less than a minute to pull off. The illusion was successful because the audience could likely imagine that the trick was “Doable,” but who would spend the clearly inordinately large amount of time perfecting something that would pass so quickly? And with roaches? Yikes!
I think great stock research strongly resembles the roach trick – you need to put in a huge amount of effort to get a small amount of useful, actionable, and legally obtained information. This has only gotten more difficult with the advent of Internet in the 15 years, since all the easy material is out there for everyone to see. It might take a legion of rocket scientists, or a cadre of mall walkers, or a survey of thousands of consumers. Real investment “Edge” takes a huge amount of effort.
#3 - It’s hard to think critically if you’re laughing.
Humans have a tough time with critical reasoning if they are distracted. Humor is a great way to turn off the reasoning mind of 500 people staring at a magician.
The analog in investing is obvious, since any emotion in the enemy of rational thinking. Doesn’t matter if you are fearful, overconfident, or somewhere in between. You aren’t thinking critically.
#4 - Keep the trickery outside the frame.
It is human nature to watch anything that is moving quickly, a fact that magicians use to great effect. The toss of a coat over a chair, a loud noise, the silly antics of a partner on stage – all serve to redirect the audience’s attention away from the real action.
Most of us spend a lot of our day considering the news headlines of the market, and that is misdirection, pure and simple. Take, for example, the national unemployment rate, which has been trending downward in recent months. What if the headline crossing the tape on the next Jobs Report Friday read “Even fewer able bodied Americans interested in working… Unemployment Rate drops further.” You might not feel so good about that news, and yet the labor force participation rate is just an important a component to the well-being of the U.S. economy as the unemployment rate.
#5 - Combine at least two tricks.
Teller spent 18 months (an great example of Rule #2) perfecting a short routine where a bouncing ball appears to jump through a hoop at his command, after first doing other tricks. The hoop jump is meant to confirm the first illusion – that anyone can command an inanimate object.
Monetary policymakers in both the U.S. and Europe have clearly mastered this rule. In a crisis, they know to launch several initiatives at once. Creating money out of thin air (or, really, bits and bytes on a computer) is a neat trick, of course. But then directing that capital to the banking system, bond markets, distressed financial institutions and other locations serves to make the illusion of liquidity even more powerful to the audience of the markets.
#6 - Nothing fools better than the lie you tell yourself.
Good magicians let you notice various aspects of their act on your own. You get to inspect a pack or cards, or see that a box appears to be empty. You believe it because of what you convince yourself you have seen. Once that belief is solidly lodged in your brain, the subsequent parts of the trick appear magical.
The role of artificially low interest rates on equity valuations is one example of this rule of magic at play in global stock markets. Since the Capital Asset Pricing Model uses the risk free rate on government bonds at the bedrock of stock valuations, a share of a profitable business should be worth more as interest rates drop. It is harder, however, to accurately factor the “real” level of interest rates when central banks are pushing them lower so convincingly. And you have to factor in the notion of “Risk free” into the equation as well, since the growth of sovereign debt in recent years makes that assumption harder to accept.
#7 - If you are given a choice, you think you have acted freely.
Magicians will tell you to “Pick a card, any card.” As a result you feel some level of control – since you picked randomly, your choice must have come from a random deck. As Teller succinctly puts it in his article: “Choice is not freedom.”
Market participants have noticed this fact with the recent – and pernicious – high correlations between previously unlinked asset classes. While this force towards common outcomes has weakened in the last few months, investors are now on the hunt for new “Asset classes” that appear to act differently than existing ones. They are searching for new choices that might allow for real freedom rather than the illusion of choice.
Rounding out this brief discussion, it seems to me that investors can benefit from reminding themselves that their own powers of perception are severely limited. If we can be regularly fooled by a Las Vegas magic act, then many of the same flaws in our thinking must be at play when we watch the screens at work. We seek out patterns that don’t really exist. We confuse choice with freedom. We grow emotional and limit our ability to process information. Watching a show, this is amusing. Making investment decisions, not so much.
http://www.zerohedge.com/news/behind...e-magic-market
Teller's illustration of the above:
For #7. If you are given a choice, you believe you have acted freely. This is one of the darkest of all psychological secrets. I’ll explain it by incorporating it (and the other six secrets you’ve just learned) into a card trick worthy of the most annoying uncle.
THE EFFECT I cut a deck of cards a couple of times, and you glimpse flashes of several different cards. I turn the cards facedown and invite you to choose one, memorize it and return it. Now I ask you to name your card. You say (for example), “The queen of hearts.” I take the deck in my mouth, bite down and groan and wiggle to suggest that your card is going down my throat, through my intestines, into my bloodstream and finally into my right foot. I lift that foot and invite you to pull off my shoe and look inside. You find the queen of hearts. You’re amazed. If you happen to pick up the deck later, you’ll find it’s missing the queen of hearts.
THE SECRET(S) First, the preparation: I slip a queen of hearts in my right shoe, an ace of spades in my left and a three of clubs in my wallet. Then I manufacture an entire deck out of duplicates of those three cards. That takes 18 decks, which is costly and tedious (No. 2—More trouble than it’s worth).
When I cut the cards, I let you glimpse a few different faces. You conclude the deck contains 52 different cards (No. 1—Pattern recognition). You think you’ve made a choice, just as when you choose between two candidates preselected by entrenched political parties (No. 7—Choice is not freedom).
Now I wiggle the card to my shoe (No. 3—If you’re laughing...). When I lift whichever foot has your card, or invite you to take my wallet from my back pocket, I turn away (No. 4—Outside the frame) and swap the deck for a normal one from which I’d removed all three possible selections (No. 5—Combine two tricks). Then I set the deck down to tempt you to examine it later and notice your card missing (No. 6—The lie you tell yourself).
Magic is an art, as capable of beauty as music, painting or poetry. But the core of every trick is a cold, cognitive experiment in perception: Does the trick fool the audience? A magician’s data sample spans centuries, and his experiments have been replicated often enough to constitute near-certainty. Neuroscientists—well intentioned as they are—are gathering soil samples from the foot of a mountain that magicians have mapped and mined for centuries. MRI machines are awesome, but if you want to learn the psychology of magic, you’re better off with Cub Scouts and hard candy.