Investing Psychology Chapter 1 Part 2: Herding, Hot Hands, and Mental Shortcuts

This is Part 2 of Chapter 1 from “Investing Psychology” by Tim Richards. If you missed the first part, go read Chapter 1 Part 1 first. We covered how your senses trick you. Now we get into how your brain takes shortcuts and how other people’s behavior messes with your money.

Herding: Copying Everyone Else

You know that feeling when you’re at a fancy dinner and you don’t know which bread roll is yours? Left or right? So you wait. You watch someone who looks confident pick theirs. Then you copy them. Richards uses this exact example. And here’s the thing: we do the same with investing.

When markets get uncertain, stocks start moving together. Up together, down together. Research from the New England Complex Systems Institute showed this. The more uncertainty, the more stocks move in sync. That’s herding in action.

We look at what other people are doing and we copy them. Even when those “other people” are just as clueless as us. Some of them just look confident. Some make a living pretending they know things. But they don’t.

Professional analysts do this too. After BP’s Deepwater Horizon oil rig disaster, economist Hersh Shefrin studied how analysts reacted. They herded even more after the event. They huddled together in their forecasts. And they still got it wrong.

But herding doesn’t only happen when we’re scared. It also happens when we’re super confident. Remember the dot-com bubble? People threw money at internet stocks because everyone else was doing it. The more people bought, the higher prices went, the more people wanted in. Nobody questioned it. Until it all crashed.

Lesson from the book: Following investment trends is not always bad. But following them without thinking is. You might end up following the herd right off a cliff. And blaming other people for your losses doesn’t make them smaller.

Salience and Scary Stories

Media loves a good crisis. Stock market crash? That’s front page news. Nothing happening? Not a story. Richards points out that we are wired to pay attention to dramatic events. Things that are “salient” stick in our heads.

News outlets know which buttons to press. Stories about disasters, crashes, dangers. These stories give us a warped view of reality. We worry way more about a nuclear disaster than about radiation from X-ray machines. But scientists say the X-rays are actually more dangerous overall.

The problem for investors: if you’re already uncertain and then the media bombards you with crash stories, you panic. You sell when you shouldn’t. Or you freeze and do nothing when you should act.

One bad experience at a restaurant makes you hate the whole chain. One scary market headline makes you dump your entire portfolio. Richards calls this out. A single story is just one data point. You need hundreds of data points to make a real decision.

Lesson from the book: Sensational stories are written because they grab your attention. They are not the full picture. Look for real data instead of reacting to stories.

Availability Bias: Your Brain’s Favorite Shortcut

This one is huge. Availability bias means we make decisions based on whatever information our brain can grab quickly. If something is easy to remember, we treat it as more important. Simple as that.

Richards gives a great historical example. People who lived through the 1929 Wall Street Crash never touched stocks again. Even though buying American stocks from 1933 to 1965 would have been one of the best investing decisions ever made.

Even Ben Graham, the “father of investing” and Warren Buffett’s mentor, fell for this. Graham lost a fortune in the crash, recovered, but the memory was so strong that he retired from investing in 1956 because he thought markets were too high. Markets kept rising for another decade. They never fell back to the levels where Graham quit. That’s availability bias hitting one of the smartest investors who ever lived.

Lesson from the book: We grab the easiest available information and use it for decisions. That’s usually a bad strategy for investing. Look for objective evidence. Don’t trust your memory.

Recent Events Trick You

There’s something called the serial position effect. If I give you a list of names, you’ll remember the first one and the last one best. The stuff in the middle gets lost.

For investors, “recency” is the dangerous part. We overweight whatever happened most recently and forget older information. This leads to two opposite mistakes:

• Gambler’s fallacy: The stock went down three days in a row, so it must go up tomorrow. (Nope. Markets are mostly random.)
• Hot hands fallacy: This fund manager picked five winners in a row, so they must be a genius. (Nope. That’s just randomness.)

Richards has a cool example with coin tosses. He shows four sequences and asks which one is NOT random. Most people pick the one that looks “too perfect” with equal heads and tails. But that’s the fake one. Real random sequences have long runs of heads or tails. We just can’t tell the difference because our brains see patterns everywhere.

Most stock price movements are random noise. But people obsess over every tiny move and build stories to explain them. That’s pareidolia applied to data. We see the Man in the Moon in stock charts.

Lesson from the book: Don’t assume recent events tell you anything about where stocks are going long-term.

Your Memory Is Not a Camera

Richards talks about “financial memory syndrome.” Our memories are not recordings. We reconstruct them every time. And recent events change how we remember old ones.

Psychologists Elizabeth Loftus and Jacqueline Pickrell showed they could plant fake memories in people. Their subjects would then add their own details to these fake memories and later couldn’t believe the events never happened.

Same thing happens with investing. After the 2008 crash, many people “remembered” having serious doubts about the market in 2007. They didn’t. They were buying just like everyone else. But their brain rewrote the story.

And here’s another problem: working memory can only hold about seven items at a time. Throw more information at someone and their decision-making actually gets worse. Company managers know this. They bury bad news in 200-page reports and put the good numbers front and center.

Lesson from the book: Keep an investment diary. Write down your decisions and why you made them. Go back and review your mistakes. Most people don’t learn from experience because they can’t accurately remember it.

Checklists Beat Brains

When you’re overloaded with information, your attention suffers. You miss things. Richards mentions a study with horse handicappers. Giving them more than five pieces of data actually made their predictions worse, not better.

His solution: checklists. Simple, boring checklists. The same tool that helped Captain Sullenberger land a plane on the Hudson River. If checklists work for landing an Airbus on water, they’re good enough for picking stocks.

Lesson from the book: Build your own investing checklist. Apply it every time. Don’t rely on gut feelings.

The Linda Problem and Priming

Richards ends the chapter with a famous experiment. Linda is 31, single, outspoken, was into social justice in college. Is she more likely to be: (a) a bank teller, or (b) a bank teller AND a feminist?

Most people pick (b). It feels right. But it’s wrong. Mathematically, the chance of two things being true together is always less than one thing being true alone. That’s the conjunction fallacy.

Why do we get it wrong? Because the description “primes” our brain. We read about Linda’s background and our brain starts matching her to a feminist stereotype. Then when “feminist” appears as an option, our brain goes “yes!” without doing the actual math.

Priming is powerful. Researchers showed that people who unscrambled sentences with words related to being old (lonely, wise, knits) actually walked slower afterward. Your brain changes your physical behavior based on subtle cues.

For investors this matters a lot. A study by Gilad and Kilger showed you could predict how risky people’s investment choices would be just by priming them with stories about risk-taking or risk avoidance beforehand. Professional investors were actually MORE affected by priming than regular people. Because the pros relied on gut instinct instead of hard data.

Lesson from the book: Priming and the representative heuristic cause us to compare things with whatever story we just heard. Develop your own tools for analyzing stocks instead of relying on whatever someone else primed you with. And never invest when you’re emotional.

Seven Key Takeaways from Chapter 1

Richards wraps up the chapter with these:

1. Everyone is biased. You, me, the pros. Many biases come from perception and memory shortcuts that work fine in daily life but fail in investing.
2. You can’t willpower your way out. These biases are unconscious. You can’t just “decide” to not be biased. But you can build systems to manage them.
3. Uncertainty makes everything worse. And stock markets are full of uncertainty.
4. People exploit your biases. The financial industry knows how your brain works and uses it against you.
5. Experience alone won’t save you. In fact, relying on experience can make things worse because you’ll generalize from your limited personal examples.
6. Slow down. Investment decisions are not emergencies. Don’t make them in a hurry or when you’re emotional.
7. Use tools. Diaries, checklists, proper data. The best investors have a system. They don’t trust their own judgment because they know it’s biased.

That’s the end of Chapter 1. Your brain has money problems. It sees patterns in randomness, copies other people when confused, overreacts to scary stories, trusts its faulty memory, and falls for priming tricks. Knowing this won’t fix it. But building systems around it gives you a real edge.

Next up: Chapter 2 Part 1: Overconfidence and Self-Image. We move from perception problems to belief problems. It gets even more personal.