The Danger of Narratives

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My Sunday Washington Post Business Section column is out. This morning, we look at a cognitive issue that has caused problems for investors: The Danger of Narratives. As we have noted repeatedly, this is hard wired in our DNA, hence the headline, Everybody loves a good story.

Here’s an excerpt from the column:

“It should come as no surprise that Wall Street also loves a good story. And when Wall Street spins a yarn, its emotional pitch drives sales.

In the parlance of the Wall Street brokers, these are called “story stocks.” You have heard them: A new CEO is bound to turn the company around. The FDA was about to give Phase 3 approval to a miracle drug with a billion-dollar market. A sexy new product launch was going to catapult the stock price. And everyone’s favorite fish tale: the imminent takeover play.

Of course, many of these stories turn out to be wrong. Surprisingly, that is not what gets us into trouble as investors. As it turns out, it doesn’t matter whether a story is true or false. It may be counterintuitive, but even true stories can end up being money-losers.

What matters most to you as an investor is the entire concept of the narrative. You have a natural tendency to want an emotionally satisfying tale — and to make investments based on that — despite times when the actual data may be telling you something different.”

The full column is worth a few minutes of your morning .  . .
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Source:
Everybody loves a good story
Barry Ritholtz
Washington Post, July 26 2013  
http://www.washingtonpost.com/business/barry-ritholtz-everybody-loves-a-good-story/2013/07/25/c6a82106-f3c8-11e2-a2f1-a7acf9bd5d3a_story.html

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