“The Iron Law of Behavioral Finance”

I wanted to share this passage from Cullen Roche of Pragmatic Capitalism:

As regulars will know, I am not a big fan of trying to claim that the market is worth “this much”, and investors think it’s worth “this much” therefore you need to be bullish or bearish. The whole concept of “value” appears nebulous to me.

So, I’d introduce the Iron Law of Behavioral Finance – the market can remain irrational longer than you can remain solvent. You might very well know the true “value” of the market at present. You might have some software or indicator that tells you precisely what the market is worth. But if the rest of the market doesn’t agree with you then your concept of value is 100% useless.

And this is the flaw in so many value approaches. While many of them reject concepts like rational expectations or the efficient market hypothesis, they implicitly embrace these views by assuming that their own view is the rational view and that that market will eventually come around to it. I reject these views and embrace the idea that the market is filled with irrational people and more often than not, understanding the market and protecting yourself within it is about protecting yourself from the madness of the crowd rather than trying to predict what it’s thinking at any given time. Or worse, waiting and hoping that this mad crowd will one day agree with your idea of what is or isn’t “valuable”….

Posted by on April 15th, 2014 at 8:02 am


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