Your investing life is too short to spend years making costly mistakes. A little psychology review might help you avoid some blunders. Think back to that Psych 101 course you took freshman year in college. Dust off your memories of behavioral psychologist B. F. Skinner.
You may recall that the "Skinner box" featured a contraption that rewarded rats with food pellets when they depressed a lever. (Yes, this really relates to investing. Keep reading.) Skinner conditioned rats to expect a pellet whenever they pressed this lever. Rats also learned to expect pellets when they were dispensed according to a fixed schedule, such as for every third or ninth press of the lever.
Then he introduced variable reinforcement, so that a pellet would be dispensed at seemingly random intervals. Perhaps after five presses first, and then after 20, and then after two. The rats would never know which press would yield a reward. Amazingly, the rats kept pressing the lever, even after many presses passed without any snack. Indeed, even when pellets were no longer dispensed at all, the rats kept pressing the lever.
You might have guessed by now where this is heading. Think of all the bad habits that investors sometimes develop, such as buying penny stocks or studying charts of stock price movements. Chances are, there was at least one occasion that served as positive reinforcement for this behavior. Maybe you bought one penny stock and beat the odds, doubling your money with it. If so, you may be continuing to buy penny stocks over and over again, losing money each time, because you've been conditioned to expect a reward -- eventually.
This effect is even more pronounced in casinos and with lottery tickets. Both offer variable positive reinforcement, enough to keep gamblers coming back for more.
Those who persist with bad habits, such as acting on hot stock tips, are likely to get burned much more often than they're rewarded. Don't let one positive reinforcement lead you to a lifetime of negative ones. Focus on fundamentals, such as a company's quality and its growth rates, and you'll take much of the guesswork out of investing.
Discuss this topic and others on our Psychology of Investing discussion board.
