Ever listen to how people speak?

I don’t mean their verbal tics or habits (“um”), I refer specifically to the words and phrases they choose to use. The way they deploy language can be quite revealing about their beliefs, training, and thought process.

Consider, as an example, the bond market. The discussion of late have been about whether or not its a bubble. This has come up quite a bit in conversation lately (see this and this), and have been fascinated by the different ways people have described the situation.

Consider the following overheard phrases, each of which come from traders, fund managers, and strategists:

The first two reflects a certain belief in the rationality of markets: “Bonds are pricing in a deflationary outcome” is how one strategist described it. Another (quoted in MSM) said that “the fixed income market is discounting a double dip.”

But a fund manager described it quite differently, relying on language of sentiment: “Traders fear an economic slowdown.

The actual language used suggest a clear theoretical underpinnings:  The first two speakers are likely adherents of the efficient market hypothesis (EMH). They consider market action to reflect the collective knowledge of all participants. Hence, the interest rate action is only the collective wisdom of the crowd, as more economic information works its way into bond prices. The crowd (of course!), will be more right versus than any single individual.

Truth be told, crowds have not appeared particularly full of wisdom over the past few years. They seem to act like lemmings, engaging in group think. If the EMH proponents are honest, they will admit this theory has flaws.

The second is a behavioral economics approach: It considers the irrational and emotional processes of the human participants in the markets. But traders who adhere to this philosophy will have to admit that the majority of the time, trader emotions remain in mostly in check. Behavioralism only seems to create actionable insights at market extremes.

I find its helpful to deploy both theories. During the meat of any market move — call it the middle 60-80% — the crowd is the trend. That is when deferring to not the crowd’s wisdom, but their collective muscle, is the most lucrative.

When the crowd morphs from a peaceful assembly to a mindless mob, that is when the behavioral aspects kick in. The contrary bet can be placed once extremes in emotions are visible in market and sentiment data.

What does your language say about the way you think . . .  ?


* Isn’t that a great headline? I made it up, but it sounds like it should be an academic research paper from HBS or one of the Fed Research departments . . .

Category: Apprenticed Investor, Contrary Indicators, Markets, Psychology, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

21 Responses to “Linguistical Differences Amongst Market Theorists: Efficient Market Practitioners vs Behavioral Economists*”

  1. Clem Stone says:

    Speaking of great headlines (and contrary indicators), check out the #1 front page story on Comcast.net this morning: “15 Signs That The US Housing Market Is Headed For Complete And Total Collapse”


    I’ve never seen anything approaching this on the front page of Comcast before. Smells like time for a bounce.

  2. Jim Greeen says:

    Maureen Dowd quotes Charles Mackay, the Scotish historian from his: In “Extraordinary Popular Delusions and the Madness of Crowds,” who observed “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.” Seems right on the money to me.

  3. Great post BR. The language we use says so much more than most of us realize.

  4. Mannwich says:

    Well, there’s some language out there that reveals far too many of us don’t think at all.


  5. dead hobo says:

    Life isn’t this complicated. Most financial pros on TV and in print are full of crap, selling something, and know they are talking to people who also know practically nothing about the subject at hand. They use what has worked for them personally and allowed them to earn a decent paycheck. Facts and expertise are only peripherally related. The only theory I use is “What do you want from me,” since none would be in public without being paid.

  6. DH

    Its not about complexity — its about listening to commentary and identifying information beyond the spoken (or written) words. Call it meta data.

    I was referencing people I have actually spoken with — I will clarify that above

    Readers should be aware that on TV in America, everyone is selling you something always.(If nothing else, their spin). If you give them your time, well then you have already bought something, paying with your time & attention if not actual dollars.

  7. Mannwich says:

    That’s why my TV stays off the majority of the time now, BR. The silence is utter bliss. If it weren’t for my waning addiction to watching sports, I’d get rid of it altogether. That’s next to go when the time comes to cut back.

  8. Bruman says:

    Dude, U R 2 funni, rofl.

    But seriously, I think you can refer to what the market indicates about the average investor (actually the marginal investor) and say “the market is pricing in..” or “the market is discounting…” without going the extra step and saying the the market is processing that information realistically or rationally. There’s a syllogism problem here:

    Efficient Marketers can talk about “the market is saying X.”
    But people who say “the market is saying X” do not have to believe the efficient markets hypothesis.

    I think the more interesting part is that if you start using the language “the market is saying X,” you can forget that this is a shorthand for “most investors appear to believe” and slip into the idea that “the market knows X.” You can become an efficient marketer without even knowing it.

    There are so many interesting directions that this can go, but I don’t want to write a long essay. It’s always nice to have some thought provoking stuff from you.

  9. dead hobo says:

    Barry Ritholtz Says:
    August 26th, 2010 at 9:41 am

    You should be aware that on TV in America, everyone is selling you something always.(If nothing else, their spin). If you give them your time, you have bought something, paying with your attention if not actual dollars.

    The way I listen is to challenge myself and ask “what are you really saying?” Which includes “what do you want from me?” This assumes I haven’t turned them off or changed channels, which happens most often. Intellectualizing everyone on TV is a massive waste of time, especially the spin folk on CNBC. The other business channels have less spin, even CNBC Asia, and have use when I feel motivated.

  10. louiswi says:

    “I never have seen a Lemming but if I ever do, I’m sure I’ll see a crowd of them”.

    BTW, I have expunged TV from my life and it has been unbelievably rewarding.

  11. alnval says:

    Great post! Sounds like you’re in the middle of the zeitgeist that is pushing us to recognize that man does not live by numbers alone. That if we truly want to find better explanations for human decision making especially in the area of economics we’ve got to understand more than we do about the human variables that go in to making them. The idea that language and thought are connected (Sapir-Whorf Hypothesis) has been around for a long time but economists have been loathe to wander into that thorny thicket because it wasn’t “real” science! That’s why I’ve been intrigued by Shiller’s acknowledgement that he gets some of his best ideas from his wife, the psychologist!

  12. Pocket QQ says:

    Nothing can screw up your “Variant Perspective” faster than Financial TV!

    But, has investor psychology completely shifted to safety, (or perceived safety) or are we still in the process? It seems like the ‘psychological herd patterns’ need updating. Who knows for sure how the flow will go, especially while the Fed is trying to maintain an orderly market. Somewhere between the two extremes exists a logical medium. It seems like an event is needed to stretch the flight to risk taking and demand.

  13. machinehead says:

    ‘During the meat of any market move — call it the middle 60-80% — the crowd is the trend. The contrary bet can be placed once extremes in emotions are visible in market and sentiment data.’

    Exactly right. And to carry it a step farther, this is why the mathematics show that market-based time series are not random Brownian motion. Rather, they exhibit ‘pink noise’ characteristics, with definite trending behavior and fat-tailed extremes which don’t conform to a Gaussian normal distribution (i.e., the standard bell curve).

    EMH’s ‘rational expectations’ disdain human emotions and biases, which are hard to measure. But they are ever-present. In general, markets spend most of the time over or undervalued, only passing through their value-based, ‘rational’ EMH equilibrium occasionally.

    This assertion renders most of classical economics into only a special case of behavioral economics, much as Newtonian physics is inadequate to describe probabilistic quantum phenomena.

  14. Bruman says:

    BTW, although I picked at your analysis a bit, I also find linguistic analysis very revealing. Something I developed as a teenager and young adult as I tried to fathom the opposite sex, but it happened to have very useful applications across many fields.

    Listening to the way people say things reveals much about the implicit assumptions that go into a thought.

    For example, what is a sentence? Essentially, it’s the minimum requirement for a complete thought. With the minor exceptions of blind intense emotions like “RUN!” “FIGHT!” “PURSUE!”, a fully formed thought has to have a subject and a verb, just like a sentence. (and even in the case of emotions, the subject is implied, “you run!” “you fight”, “you pursue”.

    As a result, the way you structure a sentence (active/passive, simple/compound/complex) reveals the elements going into a thought. Usually your thoughts are embedded in a web of ideas and emotions, and only some of them can be organized into sentences and paragraphs. Reading (or estimating) the parts of the web that didn’t fit in to what was actually said is very useful in many situations.

    Good writing then, is writing that clearly states the points and brings in as much of the embedded web as possible (or appropriate) in the fewest number of words.

    So I’ll stop here. :-)

  15. “What does your language say about the way you think . . . ?”

    It says Everything.
    (h/t alnval)
    “The argument that language defines the way a person behaves and thinks has existed since the early 1900′s when Edward Sapir first identified the concept. He believed that language and the thoughts that we have are somehow interwoven, and that all people are equally being effected by the confines of their language. In short, he made all people out to be mental prisoners; unable to think freely because of the restrictions of their vocabularies.

    An example of this idea is given in George Orwell’s book 1984, in which he discusses the use of a language entitled “newspeak” which was created to change the way people thought about the government. The new vocabulary they were given was created to control their minds. Since they could not think of things not included in the vocabulary, they were to be zombies imprisoned by the trance of their language. Soon, Sapir had a student, Benjamin Whorf, who picked up on the idea of linguistic determinism and really made it his own. Whorf coined what was once called the Sapir-Whorf hypothesis, which is more properly referred to as the Whorf hypothesis. This states that language is not simply a way of voicing ideas, but is the very thing which shapes those ideas. One cannot think outside the confines of their language. The result of this process is many different world views by speakers of different languages.

    Whorf fully believed in linguistic determinism; that what one thinks is fully determined by their language. He also supported linguistic relativity, which states that the differences in language reflect the different views of different people…”

    as an aside, ‘Economists’, trying to make Economics “a Real Science”, have, nearly, bankrupted that Field of Inquiry.

  16. Bokolis says:

    I recall that they drove me batspit crazy in school trying to do the same thing for Shakespeare.

    Is then there the implication that, when people don’t necessarily have the time to measure their words, rather than conveying a desired message, their diction will be a tell?

    It’s not all that different than a rushed pass/shot. I would have guessed that the first two went to an Ivy League camp, where they developed the EMH as their go-to move.

  17. Looked at my own language:
    Well, I used the word “bubble” 15 times. Guess what it says about my belief in EMH?

  18. Jim Bob says:

    What does it say about the way BR thinks that he chose to use “Linguistical” rather than “Linguistic”?

  19. [...] Wisdom from @BRitholtz – EMH Practitioners vs Behavioral Economists: Linguistic Differences Amongst Market Theorists [...]

  20. [...] Ökonomen Barry Ritholtz und seines in den Finanzmärkten weithin bekannten Blogs bin, hat mich ein Beitrag aus der vergangenen Woche* besonders interessiert. Denn dieser beschäftigt sich mit den beiden [...]

  21. Dear Barry,
    perhaps behavioural economics hasn’t yet fully penetrated the world of finance, but I promise you that the theory amounts to more than a handbook of emotional situations at market extremes. Prospect theory, for which Daniel Kahneman was awarded the Nobel Prize in 2002, has all by itself set a world taught to walk on its head by classical economic theory back on its feet again by finally addressing the human condition.

    Practical applications of behavioural economics have rightly earned a place in what Freud referred to as the ‘psychopathology of everyday life’. Take cognitive dissonance for example. It arises when a decision is made that doesn’t result in any particular success or profit; but instead of taking one’s lumps and cutting losses while they are still small, people are prepared to play up the decision while acknowledging only any information which confirms that choice. This selective perception, as it’s called, becomes greater as the losses mount, increasing to the point that any view which calls the original decision into question is likely to be only barely perceived. Sometimes it is even ignored completely. Of course, there is also a multiplier-effect: only the selectively perceived information is passed on.
    As a result, the events first observed and described by those who study behavioural economics usually play a significant role already in the early stage and then in the subsequent development of large market trends.

    (Look for the full text my reply at http://www.unexpectedutility.com)