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 .  . .


Everybody loves a good story
Barry Ritholtz
Washington Post, July 26 2013  

Category: Apprenticed Investor, Investing, Psychology

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.

12 Responses to “The Danger of Narratives”

  1. bizprof says:

    Excellent article (excellent series of articles on narratives mentioned in the WaPo comments, too)…one of the big issues with narratives is that people seem to rewrite them in their own minds as they come to identify with the subject of the story. This works in hiring people, choosing politicians, close relationships, and buying stocks…if the original story starts to be shown wrong, just rewrite the story!

  2. constantnormal says:

    I certainly agree that “everybody loves a good story”, and an example that springs to mind is the infallibility of “reversion to the mean” story, which somehow never manages to mention that what “mean” we are reverting to depends heavily on the time horizons we use in the sample of data we use to calculate the “mean” we are reverting to, and how we allow for undershooting and overshooting that mean … for example, if we look at 10-year Treasury rates, we might arrive at different means that we are oscillating about, if we look at the data over the past 50 years, we get a different mean than if we look at the data since 1871 …

    In the 50-year window of data, we might be able to argue that the “mean” of the 10-year Treasury rate is somewhere between 5% and 6%, expect a huge collapse in the current bond prices (and all the things that would come by association), whereas with the longer time horizon, one is more receptive to the idea of a slower rise in rates.

    One can credibly argue that the debt markets US of the 19th century were completely different from those of the 20th century (or the 21st), or point back to the immense reserves of natural resources available to be exploited then (by a comparatively small population) compared to now. Or maybe contrive some sort of index of technological progress and map rates against that. There are a LOT of ways to measure the multitude of things that influence rates, time being only one. This leads to a LOT of different “means” for reversion to, and the notion that rates do not revert to a mean as dictated by a single variable tends to destroy the whole notion of the predictability of “reversion to the mean”.

    But those complicating ideas only muddy up a good story, regardless of the story that Reality is chaotic and does not adhere to strict cycles, instead having more the character of a random noise signal possibly correlated to population or per capita wealth or economic inequality or … you get the idea … the universe of Stories is vast, but the universe of Reality makes the universe of Stories look small.

    Still, when the dust settles, we all have to get up on Monday morning and strap on the harness. A good story helps to pass the time, while Reality makes other plans.

    Following the data is helpful only when it works — which it seems to an astonishing portion of the time, but not all the time, especially when everyone is locked into a common story and is following the same data.

  3. barbacoa666 says:

    Those who are suckers for narratives are a diverse group. But they hold the common philosophy that, though lacking evidence, their belief system must be accepted by everyone as valid. And of course, unbelievers must be punished. Other narrative-driven groups of people:
    -Fundamentalist religious people
    -Republicans (the entire party platform is based on a set of narratives)
    -Anti-vaccine, anti-GMO crowd (though not all resistance to Monsanto)
    -A portion of the climate change crowd (those strictly driven by using it as a means to an end)
    -Deniers of human-driven climate change
    -Open and closed borders proponents

  4. constantnormal says:

    nuts. The link I was aiming for didn’t make it. Here is the url of the page containing the chart I was referring to …


  5. constantnormal says:

    BTW, BR, a tip ‘o the hat to you for a damfine piece on this.

    Made me think a lot (which unfortunately, only occasionally leads to reliable and useful conclusions — but much more often than thinking a little does).

  6. wrongtrade says:

    we can agree on the importance of mean reversion, but with respect to the 150% bull market from the March 2009 lows: at that time, had not the market barely even not quite touched the historic averages of long term valuation metrics, much less over correct? (tendency toward overcorrection being another valuable concept if examining long, cyclical market behavior).

  7. faulkner says:

    You note that stories are in our DNA and then advise people to avoid them and deal in facts. The psychologist George Kelly noted over 50 years ago, “… the facts assume their particular shapes only in the light of a certain theory,” or story/narrative. So, the question is not whether to tell stories, but what stories to tell when.

    The research into narrative is clear that most stories are created and told post-hoc with little predictive value. Their ‘purpose’ is to bind events together to give a meaningful shape to experience as well as maintain a positive sense of self/egotism. (In Kahneman’s terms, System 1.) As you wrote, the shape of the story is “dependent upon what happens next” – which post-hoc may revise the story, or not, and either way is not likely to be noticed consciously.

    So what is an investor to do? First, realize you cannot not tell stories, and then revise the stories you tell. The most important story is the one you tell about what kind of investor you are. I have admired your own willingness to step up and say you are “wrong on a regular basis.” This gives you considerable flexibility and a distinct advantage over those whose stories include how brilliant, insightful or prescient they are.

    Next, manage your story input. If stories were not in our DNA, there wouldn’t be multiple billion dollar story generating industries, and Wall Street tells many more fairytales than Disney. The thing is, once a story – a series of clear and vivid images – are in your mind’s eye (and emotions), they are difficult to displace without a strategy. And a strategy is a higher level, and energy consuming, mental function. So, start with managing input.

    I have been reading older trading and investing books lately, and I find lots of this kind of advice. The authors just didn’t have the neuroscience to back up what they could see and hear going on around them.

  8. culhnd says:

    Nice pivot to the importance of a feedback loop. “The map is not the territory” – the narrative is just a simplified representation of the world. Data gets reconfigured into a narrative to be digestible, but we should always loop back to data to review and update that narrative – keep updating your map based on the facts on the ground. And always keep in mind that some other guy’s map was more accurate after all.

  9. TDHawk says:

    Narratives are easy and object oriented. No person is going to gather all the facts and walk someone through the inner workings of a complex system with thousands of relevant working parts. Facts are tied together via intuition. This theory on narratives is a narrative and has quite some emotions too! …Quotes are rife with emotions “Who you gonna believe — me or your lyin’ eyes?”

    Now for the bearish narrative:
    Pro: They are right on the money on unsustainable problems.
    Con: They doubt the amount of positive thinking that can prop up an economy.

    Bullish narrative:
    Pro: They won big being able to correctly factor in the powers of positive thinking to prop up bubbles.
    Con: They may not be aware enough of the piling flammable dead wood.

    Also the Euro austerity narrative depends on how people define austerity as either higher taxes or more spending cuts.