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What if Mr. Market were the consummate salesman using sophisticated sales tactics inspired by Cialdini’s The Science of Persuasion to seduce us to buy his merchandise?
Is it any wonder that ordinary investors don’t stand a chance, ending up over-paying and then dumping the acquired goods once they realize they never really wanted them in the first place (i.e., buying high and selling low)?
Professor Cialdini’s brilliant work on the Psychology of Persuasion is considered required reading by any aspiring salesperson. Let’s review his six fundamental principles of persuasion and see if there are any parallels to Mr. Market and investor behavior.
1. Principle of Liking
People follow those they like.
The example Cialdini cites is the Tupperware party, where guests purchase products because of their fondness for their host.
Applied to investing: Do you find yourself buying shares because the stock chart looks nice or your favorite TV personality says it’s a buy?
2. Principle of Reciprocity
People repay in kind.
Examples are charity events, gifts, marketing samples, and even praise.
Applied to investing: Do you want to buy more after the shares rise in value because you believe your stock picking ability was validated by the market?
3. Principle of Social Proof
People like to be part of the herd.
Examples are testimonials and the “everyone else you know has it” argument.
Applied to investing: Buying a popular stock because everyone you know seems to own it even though you haven’t done the work to know if the shares are over-valued or under-valued.
4. Principle of Consistency
Once people publicly commit to a course of action they feel compelled to stick with it.
Applied to investing: Do you find yourself holding on to that oil-and-gas company shares, even though the company is burning cash and the stock is down 50% because last year you told your friends that oil is going to $160? Professional managers often fall victim to this principle.
5. Principle of Authority
People defer to experts.
Applied to investing: Did you buy shares of that hot biotech stock thanks to a ‘tip’ from an authority figure (a famous TV personality perhaps or your broker) even though you have no idea what they do?
6. Principle of Scarcity
People want what’s hard to get.
Applied to investing: You see shares of a stock going up every day and you feel a sense of urgency to buy before its “too late.”
The next time you find you’re making an investment decision backed by emotion rather than analytical rigor, stop to consider if it isn’t one of Cialdini’s principles of persuasion at work.
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