Thursday, April 18, 2019

Cognitive Priming and Trend-following - Not a Bad Thing


Cognitive priming is a real effect that has often not been discussed with investment decisions and behavioral finance. Suggestions can be used to steer the behavior of investors.  Priming is the use of stimulus to create a memory effect or create a temporary increase in accessibility of thoughts and ideas. It is the non-conscious use of memory. It could be used to increase both positive and negative thoughts, ideas, and behavior. Businesses have constantly used priming in advertising to help steer or suggest positive memories. Psychologists have tested priming for years and find that the power of suggestion or linkage is real and extensive. At the extreme, think of Christopher Nolan's movie Inception on the idea of implanting ideas in memory.

Priming can be occur with how investment ideas are presented or focused. This can be both good and bad. We are primed by the ideas we hear in the news, through the research we read, and through talk with peers. Priming can occur with alerts. These simple forms of priming are not surprising. 

I suggest that there is another source of priming that we do not give much thought - trends. A trend that flashes on a screen is a priming device. If you tell someone the price trend or show them a chart with a trend-line, there is an immediate memory imprint. Investor thinking is now filtered through this prime. Many will be stuck thinking that they want to be a long the trend. They will focus on looking for confirming evidence. Of course, there are others that want to fade a trend but again they are primed through the price action. If trends have continue or have memory, then many investors will be primed to think that trend-following is profitable. This is not system of trading but the memory response from seeing the trend priming. Nevertheless, there is the added effect of potential herding.

Many have highlighted the evils of priming. That does not have to be the case. Primed events help focus attention and in a cluttered world, gaining attention may be a good thing. What is critical is appreciating that cognitive priming is occurring.   

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