Word Of Mouth - Stock Tips

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

Robert J. Shiller, in his excellent book, Irrational Exuberance, wrote about the innate human trait of sharing information, especially in person to person exchanges:

The human mind is the product of evolution almost entirely in the absence of the printed word, e-mail, the Internet, or any other artificial means of communication.  Human society has been able to conquer almost all habitats of this planet primarily because of its own innate information processing ability.  A fundamental component of this information processing ability is effective communication of important facts from one person to another.

This superior ability to communicate knowledge has been made possible over the past few million years by evolutionary changes within the human brain that have optimized the channels of communication and created an emotional drive to communicate effectively.  It is because of this emotional drive that most people's favorite activity is conversation.....The incessant exchange of information is a fundamental characteristic of our species.

Word of mouth transmission of ideas appears to be an important contributor to day-to-day or hour-to-hour stock market fluctuations, even though direct word-of-mouth transmission cannot proceed across the nation as fast as markets move.

Human communication is basically the sharing of knowledge; something that has been going on between people since language first developed.  Any time two or more people meet, they communicate; they pass information of one sort or the other.  In light of the inherent uncertainty in the market, individual investors are always open to information that is seen as reducing investment risk.  You must remember that any such information, regardless of how presented, can be only one of three things: fact, rumor or opinion.  

As human beings, we strive to learn things in order to reduce life's uncertainty.  As investors, however, we must resist the urge to act upon one form of communication:  the stock tip.  In the last post, we ended with the caution against gambling on Wall Street.  One type of market gambling is investing on a tip from someone.  Usually that person will claim some inside information; facts not generally available to the investing public at the time.  The investor needs to "go slow" when presented with a tip.  Facts and rumors can be checked out.  Opinion is just that, which makes it no better than an investor's personal analysis of a situation.  Opinions differ.  As they say, "That's what makes a horse race."  The investor must weigh the other's opinion against his or her own information.  If the tip is truly inside information, acting on it is illegal in the USA.  Investors can't hide their trades from the government computers monitoring the market.

Although recounted in an earlier blog about Philip Carrett's book, The Art of Speculation, I feel his advice on "inside information" is worth repeating.  Avoid "inside information" as you would the plague. Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market.  He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story.  Such lack of self pride would, in Mr. Carrett's view, be "well rewarded."

SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, Reprinted by permission of Princeton University Press.

The The Art of Speculation by Philip L. Carret, remains in print today.

Comments are always welcome.