Investing Psychology Chapter 3 Part 2: Mood, Persuasion, and Market Anomalies

Previous: Chapter 3 Part 1

We’re still in Chapter 3 of Tim Richards’ “Investing Psychology.” In Part 1, we covered how situations mess with your head. Now let’s talk about something even weirder: your mood, the weather, and why shouting “Fire!” in a theater is basically what happens during a market crash.

Getting Old Actually Helps

Here’s some rare good news. Experience actually makes you a better investor. Unlike most biases where knowing about them doesn’t help, the disposition effect (selling winners too early, holding losers too long) actually fades with time.

Researchers Amit Seru, Tyler Shumway, and Noah Stoffman found that older investors diversify more, pick less risky stocks, and fall for the disposition effect less often. Three groups improve the most:

1. Unsophisticated investors - they have fewer bad habits to unlearn
2. People who started with terrible returns - the ones who stick around really want to learn
3. Women - less erratic, less affected by situational traps

But here’s the problem. We don’t want to get old slowly. We want the shortcut. So instead of learning from experience, we copy some billionaire entrepreneur. And that’s survivorship bias talking. For every successful startup founder, thousands failed. The survivor just got lucky. One in six British teenagers thinks reality TV is the path to fame. Same logic.

The real lesson: learn from people who already went through the pain. Don’t wait 20 years to figure out what they already know.

Conversations Are Biased Too

Ever notice how nobody at the investing club talks about their losses? Everyone brags about their wins. Richards calls this out. We all present ourselves in the best light, and we all know we’re doing it. But we somehow forget that other people are doing it too.

DeMarzo, Vayanos, and Zweibel found something called persuasion bias. If you keep reading the same columnist, you start treating each new article like independent proof they’re right. It’s not. It’s the same person saying the same thing. But your brain counts it as separate evidence.

On the internet, this gets worse. A few opinion leaders shape what everyone thinks. Their ideas bounce around networks until it looks like thousands of people independently reached the same conclusion. They didn’t. It’s the same source, repeated and amplified. This is how irrational market beliefs get built.

The fix is simple but hard: discount what you hear from social networks. If you can’t critically analyze the information, you’re better off ignoring it completely.

Scammers Know Your Biases

Our brains take shortcuts because the world is too complicated to analyze fully. Scammers live in the gap between reality and our limited processing power. They exploit specific biases: our tendency to trust authority figures, our greed, our fear of pain, our need to be liked. In the UK alone, people lose over $5 billion a year to scams. Financial literacy doesn’t protect you.

Richards recommends Robert Cialdini’s book “Influence” here. The key idea: recognize the hidden persuaders before they get to you. One classic trick is the contrast principle. A scammer offers something expensive first, then “drops” the price. You feel like you’re getting a deal. Same reason people buy a stock just because it fell from $100 to $50 without checking if $50 is actually a good price.

Sad Investors and Seasonal Mood

About 20% of people suffer from Seasonal Affective Disorder (SAD). They get depressed in winter due to lack of sunlight. You’d think this wouldn’t affect stock markets. You’d be wrong.

Researcher Lisa Kramer found that U.S. Treasuries have an 80 basis point difference in monthly returns between April and October. The pattern shows up in both Northern and Southern hemispheres (flipped by six months, matching their seasons). It can’t be a coincidence.

SAD investors get more risk-averse during winter. They shift money into government bonds in the fall and back to stocks in the spring. Only 20% of people have SAD, but when enough investors herd in the same direction, it moves markets.

If you’re someone who gets the winter blues, be extra careful about making investment decisions during those months.

Sell in May and Go Away

Seasonal patterns don’t stop at SAD. There’s the famous January effect where small cap stocks outperform at the start of the year. Some think it’s tax-related. But the effect appears in countries with different tax year dates. So that theory doesn’t hold up.

Here’s a fun one: people born in summer are luckier than winter babies. Psychologist Richard Wiseman tested this. He had people scan a newspaper that contained a hidden reward notice. Lucky people (mostly summer-born) spotted it way more often. Maybe summer babies get more freedom to explore as infants. Small early differences in environment can shape personality.

Ben Jacobson and Wessel Marquering studied “Sell in May” and found that yes, selling in May and buying back in the fall does produce better returns. The Halloween effect (buying end of November) works too. Nobody knows exactly why.

Richards’ advice: don’t follow the sayings. Focus on actual valuations. If stocks are cheap in November, buy them because they’re cheap, not because of a calendar rule.

Vanishing Anomalies and Bangladeshi Butter

Here’s the thing about market anomalies. As soon as someone discovers one, it starts to disappear.

Richard Sloan published a paper in 1996 about the accrual anomaly. Companies with high accruals (profits they haven’t actually received yet) tend to disappoint. Makes sense. Promises aren’t cash. The market was mispricing this. Hedge funds hired Sloan and others, built algorithms to exploit it, and within a decade the anomaly basically vanished. This is Andrew Lo’s adaptive market in action.

And some anomalies never existed in the first place. Statistician David Leinweber proved this brilliantly. He went looking for anything that predicted the S&P 500 and found that Bangladeshi butter production predicted 75% of the variation. Add U.S. butter, cheese, and sheep populations? 99% accuracy. Obviously this is nonsense. But it looks just as statistically solid as many “real” trading models.

Same goes for the Twitter mood research. One paper showed tweets predicted the Dow Jones with 87.6% accuracy. Even if true, once everyone knows about it, the edge disappears. More likely, it’s just another case of finding patterns in random data.

Fire in the Theater

Imagine a crowded theater. Someone yells “Fire!” The best outcome is everyone stays calm and files out orderly. But the people in the back are getting toasted, so they panic. Their panic causes everyone to panic. More people get hurt than if everyone stayed calm.

This is the fallacy of composition. What’s rational for one person becomes destructive when everyone does it. Stock markets work the same way. When prices fall, selling makes sense for you individually. But when everyone sells at once, prices crash even harder. The economy goes into a tailspin.

Richards has one clear rule: don’t borrow money to invest in stocks. The worst time to be forced into selling is when everyone else is selling too. If you’re loaded up on debt during a crash, you have no choice. You’re that person in the back of the theater, making things worse for everyone including yourself.

You Can’t Beat the Machines

Investment institutions have billions of dollars, the brightest minds, and supercomputers running high-frequency trading algorithms. They use the theory of relativity to figure out where to put their servers for microsecond advantages.

If you discover a clever trading pattern, they already found it, built code to exploit it, and squeezed every penny out of it. You can’t compete with that.

But here’s the thing. The machines are obsessed with short-term returns. They have to be. Their clients demand quarterly performance. Private investors don’t have that problem. You can think in decades. You can ride out crashes instead of being forced to react.

Your one real edge over Wall Street is patience. Use it.

Chapter 3 Key Takeaways

Richards wraps up Chapter 3 with seven ideas:

1. The disposition effect makes us sell winners and keep losers. Recognize it.
2. Halo effects make us think one good trait means everything is good. Watch for it.
3. Noise traders cause price movements that mean nothing. Ignore them.
4. Weather, seasons, and sunlight actually move markets. Don’t let your mood drive your portfolio.
5. Market anomalies vanish once everyone knows about them. No permanent shortcuts exist.
6. Institutions will always beat you at short-term trading. Think long-term instead.
7. Be skeptical of new “sure thing” methods. They’re probably data mining. Bangladeshi butter doesn’t predict the stock market.

The bottom line: your situation, your mood, your social circle, and your environment are all pulling strings you can’t see. The best defense is knowing they exist and having a plan you stick to regardless.

Next up, we get into social pressure and groupthink. Because if you thought your own brain was bad, wait until you see what happens when brains get together in groups.

Next: Chapter 4 Part 1