Don't Be Like a Lawyer

“When I see a bubble forming, I rush in to buy, adding fuel to the fire” — George Soros

Photo by Tingey Injury Law Firm

Don’t get me wrong. Law is a noble pursuit. Quite a lucrative one. But I’m not going to talk legalese today. What I want is that you stop being like a lawyer. Yes, you behave like a lawyer. Even if you’re not aware of it. But you’re not alone, because I do, too.

Lawyers choose a version of reality and try to persuade a jury that it’s true. They find strategic arguments to support their side. And conveniently ignore anything else that contradicts it.

This is how most people think. They don’t try to convince a jury, but themselves and their loved ones.

People fall in love with their own ideas. Some build their identity around them even. When this happens it’s really hard to take in contradicting information. Doing so would mean reconsidering who you are deep down. And that’s… Inconvenient.

An open market

Karl Popper wrote a book named The Open Society and Its Enemies. It connects epistemology with political science. He extends the concept of falsifiability to societies.

Falsifiability posits that nothing can be verified — only falsified. I’ll illustrate this with water.

Water boils at 100º C. That’s a universal fact. Everyone accepts it and considers it true.

But Popper differs.

According to Karl, we can’t say it’s true for certain. It’s simply not false — yet. It’s an observation that explains reality very well. But there’s no guarantee it will continue to be so in the future. So we can’t say it’s true. We can’t verify it — only falsify it.

An open society is therefore a society that doesn’t take anything for granted. Tradition and religion would fall under strict scrutiny in such a society. An open society questions everything. Every mental model of reality is a description that is updated with new information.

Now apply this to financial markets.

We have bears and bulls. The former expect the market to drop — the latter, to raise. Most investors belong to either group. They’re all lawyers. But the ideal investor should belong to no group. She should inhabit an open market.

An open market would accept regulations when needed. But it wouldn’t accept the role of central banks. Interest rates should be determined by the market itself.

Is an open market realistic though?

…and its enemies

An open market would be boring, to be honest. It would be efficient, in the sense of the Efficient Market Hypothesis. No one could make a profit through speculation. There would be no free lunches. Meh.

The markets’ efficiency depends on the agents’ information. Namely, it depends on the degree of diversification of information. When information is evenly diversified, opinions are diverse and heterogeneous. As a result, agents price assets correctly.

But these are all fairy tales. Or, in George Soros’ words:

I am not well qualified to criticize the theory of rational expectations and the efficient market hypothesis because as a market participant I considered them so unrealistic that I never bothered to study them.

An open market is utopian. Financial history is rife with bubbles forming in a wide array of asset classes. Mostly because people behave like lawyers. Lawyer-like behaviour is the main enemy of an open market. But also the main reason why there are free lunches.

Lawyer-like behaviour is fuelled by confirmation bias. People consume information that reinforces their worldview and ignore data that casts doubt on it. Many ideas have both supporting and contradicting evidence. And we choose whichever suits us better.

Be like a scientist

Scientist aren’t immune to confirmation bias. But their method is designed to minimise its effect. Investors should follow the scientific method too. But applied to financial markets.

1. Form a hypothesis based on your observations.

2. Test it against the market,

3. Learn from it.

4. (a) Stick to the initial hypothesis, or (b) formulate a new hypothesis.

In a nutshell: don’t be like a lawyer. Be like a scientist.

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Have you ever behaved like a lawyer? What ideas make you behave that way?

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Photo of the week

Last weekend I found a deserted beach. I thought it was a good opportunity to do some gymnastics.

Alejandro Lopez — The Psychology of Wealth