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Objects in the Rear-view Mirror

Didn't you already know how the market was going to behave

It's a story that every Indian above a certain age knows by heart. Two small time thieves are being transported in a train by a police inspector. Dacoits attack the train and the three fight them off. The inspector is injured and the thieves are faced with a dilemma. During the course of the fight they've come to respect and admire the inspector's bravery. Now, if they leave him to his fate, he will die and if they get help they'll get arrested. In the end, one of them pulls out a coin and suggests that they toss to decide what to do. The coins decides that they must help the policeman and thus begins Sholay--the movie we all know by heart. And as we all know, the decisions made by the random flip of the coin in the movie aren't actually random. The coin has heads on both sides (or was it tails on both sides? I've forgotten!) and the decisions are actually being made by the Jai, who's the one flipping the coin.

It's a decision-making process that looks random but actually isn't. Come to think of it, that's the exact opposite of what generally happens in life and is certainly happening in the stock markets now. Things are actually random but there are a large number of people who are trying to convince others that they know what's going on. In most cases, they are fully convinced themselves. Interestingly, since the stock markets tanked in January, I find this hindsight problem has become even more acute. Why has that happened?

There were gurus who were predicting doom, there were those who were predicting that things will become better and there were those who were saying that they will remain about the same. All three types are now claiming success. The way the markets have moved up and down and sideways in fits and starts has enabled gurus of all persuasions to be able to say that they were correct. This very different from the preceding years, when by and large, only the intensely optimistic could claim to have predicted things correctly. Therefore, the hindsight industry is now in full flow.

But don't get me wrong--I personally interact quite regularly with many of the people I'm talking about right now (in fact, I suspect I'm one of them) and it's quite clear that in almost all cases, they are not falsifying what they said earlier. All of us suffer from a genuine hindsight bias. Hindsight bias is a serious psychological phenomenon and is extremely insidious in the way it works. After something has happened, we manage to convince ourselves quite well that what has actually happened was what we had thought would happen.

The problem is that once we start make ourselves believe that we were right in our past predictions, we start expecting the same from our future predictions. Unfortunately, this is quite difficult since the future hasn't actually happened yet. I've found that one has to work consciously to avoid this trap of hindsight bias. All kinds of investment markets are currently in a period of random behavior. Every day you'll change your opinion five times about what is going to happen. Eventually, one of those opinions will turn out to be correct. When that happens, try not to convince yourself that that the correct one was the only opinion you ever held.