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Investing and the Irrational Mind: Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss

Investing and the Irrational Mind: Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss

by Robert Koppel


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Make RATIONAL decisions in the IRRATIONAL world of investing

"Readers will find within these pages new truths that will help transform their thinking. This is more relevant than the latest strategies, trading systems, or technical chart formations."

—William J. Brodsky, Chairman and CEO, Chicago Board Options Exchange

"Koppel offers pioneering insights, backed by substantial research, that help explain how psychology influences financial decisions and drives markets. Investing and the Irrational Mind is a must-read for both the professional and nonprofessional investor."

—Robin Mesch, President, Mesch Capital Management

"If there is truth to the Yiddish proverb that 'man plans and God laughs,' read Investing and the Irrational Mind to gain an essential understanding of what to do with your stocks and bonds when God is cracking up. As the sages advised, 'All the rest is commentary.'"

—Yra Harris, CME Group member, President of Praxis Trading, and author of the daily investment blog Notes from the Underground

"Investing and the Irrational Mind explains the psychological barriers to making good investment decisions—and more importantly how to overcome them. Koppel shows the dangers of our own habit-driven behavior, biases, and heuristics and how they lead us to violate our own investment axioms."

—Alexander Abell, Director, BlackRock, Inc.

"Investing is fraught with uncertainty, which gives rise to psychological issues that investors ignore at their peril. Bob Koppel has written a fascinating, entertaining, and comprehensive examination of this multifaceted area of inquiry. If you invest for a living, or even if you're just a student of the psychology of self, you will find beneficial insights in the pages of this book."

—A. Thomas Shanks, President and CEO, Hawksbill Capital Management

About the Book

Most investors are driven by greed and panicked by fear, which is why so many lose so much during market upheavals. It's also why so few gain so much. What separates the winners from the losers? People who remain calm, focused, and analytical during market ups and downs always come out on top—and snatch the losses of those who panic.

Investing and the Irrational Mind gives you the tools for overcoming the self-destructive impulses that stand between you and profit. Behavioral finance expert Robert Koppel reveals why your brain sends certain negative messages during the investing process. Applying the latest advances in neuroeconomics and insights from top traders, he provides a program for building the habits used by the world’s most successful investors.

Investing and the Irrational Mind teaches you how to:

  • Identify negative, self-defeating patterns of thought
  • Tailor your goals according to your particular investing psychology
  • Develop a framework for overcoming irrational thoughts in investment decisions
  • Use one of your most powerful investing tools—intuition

The investing world operates by the law of the jungle, with a new surprise lurking around every corner. How often have you abandoned a perfectly sound investing strategy because you panicked? "Success requires focused concentration that permits an unbiased perception of the market," writes Koppel. "All we can ever control is ourselves, but that is more than enough."

Armed with 30 years of experience as an analyst and fund manager, Koppel helps you develop a focused, disciplined, confident, and profitable approach to investing using the best tool at your disposal: your brain. Filled with surprising insights into human behavior and rock-solid financial advice, Investing and the Irrational Mind helps you draw consistent profits in an inconsistent investing world.

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Product Details

ISBN-13: 9780071753371
Publisher: McGraw-Hill Professional Publishing
Publication date: 03/21/2011
Pages: 304
Product dimensions: 6.20(w) x 9.10(h) x 1.30(d)

About the Author

Robert Koppel is a former member of the Chicago Mercantile Exchange (CME), a hedge fund partner, and president of his own division at Rand Financial. The author of numerous books on the psychology of trading, Koppel was the senior business writer for His work has appeared in the national financial press and been featured on CNN, CNBC, and NPR.

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Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss


The McGraw-Hill Companies, Inc.

Copyright © 2011Robert Koppel
All rights reserved.
ISBN: 978-0-07-175337-1



A Concise History of Investor Psychology

In May 2008, in an interview with the New York Times, Kenneth C. Griffin, president and CEO of the $20 billion Citadel Investment Group, a leading global financial institution, offered some pretty harsh words about Wall Street. His gripe was with the Street's prevailing psychology of reckless and excessive risk taking. He called for an immediate overhaul of its mindset. No stranger to placing big bets, Griffin knew what he was talking about. While an undergraduate at Harvard, he had started two hedge funds from his dorm room, installing a satellite dish to channel real-time market data so that he could trade between classes. Founded in November 1990 with a little over $4 million, Citadel is now the world's eleventh largest hedge fund, earning Griffin a reported $900 million in 2009, after a double-digit drawdown in 2008.

Upset by the failure of Bear Stearns and the mistakes of big-name money managers and CEOs who assumed catastrophic risks that led to the evaporation of billions from their balance sheets and whose actions eventually led to the disappearance of Lehman Brothers and the near collapse of the financial system, he made an assessment that was blunt and to the point. "We, as an industry, dropped the ball," he said. "We have a responsibility to manage risk in a way that is prudent."

Was Wall Street once again guilty of hubris? According to Griffin, the problem was a market psychology that allowed for too much risk compounded by weak government oversight. "When you read that UBS did not even view parts of its mortgage portfolio as having risk," he said, "it becomes very obvious that a number of firms were not dotting the i's and crossing the t's when it comes to risk management."

He also cited the additional problem of youth and inexperience. "Walk across any of the trading floors—they are full of twenty-nine-year-old kids," he explained. "The capital markets of America are controlled by a bunch of right- out-of-business school young guys who haven't really seen that much. You have a real lack of wisdom."


Wall Street Journal reporter Scott Patterson's electrifying portrait, The Quants, describes how a group of brilliant, gutsy traders, composed of math geniuses and physicists, first earned their chops through gambling, then moved to take on Wall Street. Accentuating the quirky intrigue of this group, Patterson details the personalities and temperaments of its characters. Its principal figures included Citadel's Ken Griffin; chess master Boaz Weinstein of Deutsche Bank; Peter Muller, manager of Morgan Stanley's secretive hedge fund Process Driven Trading (PDT); Cliff Asness, the founder of the nearly $40 billion fund AQR Capital Management; and Ed Thorp, an MIT-trained mathematician and card shark, hedge fund manager, and author of Beat the Dealer, the first book to statistically prove that the house advantage in blackjack can be overcome by card counting.

This story opens not long ago in the Versailles Room, which is as posh as its name suggests, in Fifth Avenue's storied St. Regis Hotel. Beneath a gilded ceiling, antique floor-to-ceiling mirrors revealed the players, the quants, competing at Wall Street Poker Night. These yearly red-carpet events and tournaments, benefiting Math for America, brought together quants and professional poker players, surrounded by beautiful women, to play high-stakes, blue-chip poker. "The small group of wealthy and brilliant individuals ... had, through sheer brainpower and a healthy dose of daring, become the new tycoons of Wall Street," reports Patterson. "Few people outside the room had ever heard their names. And yet, behind the scenes, their decisions controlled the ebb and flow of billions of dollars coursing through the global financial system every day." This was not Gordon Gekko's 1980s game of liar's poker.

More than anything else in the world, the quants were searching for their truth. For the quants, it was revealed in the obscure patterns of the market, which could be discovered only through mathematics. These young masters of the universe devised an appropriate name for it: alpha. Alpha, Patterson explains, is defined as a "code word for an elusive skill certain individuals are endowed with that gives them the ability to consistently beat the market."


The desire to beat the market is not a new idea, nor has it been limited to quants or to capital markets. When it comes to speculation, we are looking at a dramatic history of booms and busts. Our minds are irrationally fueled by the prospects of quick enrichment through such things as tulips in Holland, gold in Louisiana, real estate in Florida, art, Internet stocks, and mortgage-backed securities. We are driven by greed. We are panicked by fear.

Combining psychology, economics, and neuroscience, the recent field of neuroeconomics studies how people react in these emotionally exuberant situations. Looking at the role of the brain, researchers examine how we evaluate investments, categorize risks and rewards, and interact with one another in our economic transactions. However, the story of our attempt to comprehend the relationship between investing and the irrational mind begins much earlier.

Since the inception of modern markets, investors have sought to understand the factors that assured profit and prevented individuals from getting caught up in a psychological ricochet between euphoria and depression. One of the first attempts was made by Dickson G. Watts, president of the New York Cotton Exchange from 1878 to 1880, a great arena of economic activity in America. In Speculation as a Fine Art and Thoughts on Life, in his list of essential qualities of the speculator, Watts wrote, "Those who make for themselves an infallible plan delude themselves and others."

Watts identified five qualities that he believed were key for success: self- reliance, judgment, courage, prudence, and pliability. Summing up, he wrote, "The qualifications named are necessary to the makeup of a speculator, but they must be in well-balanced combination. A deficiency or an overplus of one quality will destroy the effectiveness of all. The possession of such faculties, in a proper adjustment is, of course, uncommon. In speculation, as in life, few succeed, many fail."

It was a good early attempt to understand a near chaotic speculative environment, one that relied heavily on nineteenth-century moralistic teachings and everyday common sense.


These observations won Watts the attention of young Jesse Livermore, who learned a lot about markets and himself from the slim volume, as revealed in Livermore's classic 1923 work on the art of speculation. Reminiscences of a Stock Operator, the fictionalized biography of the Boy Plunger, as he was known, charts the first-person experiences of Lawrence Livingston, a thinly disguised Livermore, through his progress in mastering Watts and the world of stock speculation to become one of Wall Street's most successful traders.

First appearing as a series of 12 articles in the Saturday Evening Post, Reminiscences of a Stock Operator was published under the name of its editor, journalist Edwin Lefèvre, a friendly newspaperman whom Livermore used as a source of information and as a plant to disseminate favorable news items. The book chronicles a trajectory of speculation that begins in the New England "bucket shops," brokerage firms, now illegal, that took the opposite side of customers' orders without having the orders actually executed on an exchange. The term itself derives from the fact that customers'

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Table of Contents

Foreword vii

Preface xi

Acknowledgments xv

Introduction 1

1 A Concise History of Investor Psychology 9

2 The Inner Game 25

3 Hardwired and Irrational 33

4 A User's Guide to the Brain 49

5 The Market: It's a Jungle Out There 59

6 Things Fall Apart 81

7 Defining the Big Picture 101

8 Cognitive Biases 117

9 Fallacies 135

10 Illusions 151

11 Taking a Loss 171

12 Risky Business 187

13 The Power of Intuition 205

14 Adversity and Resilience 225

15 The Psychological Challenge 241

Notes 255

For Further Reading 279

Index 285

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