Nassim Taleb, in no uncertain words, shares his opinion on journalism in Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets:
Try the following experiment. Go to the airport and ask travelers en route to some remote destination how much they would pay for an insurance policy paying, say, a million tugrits (the currency of Mongolia) if they died during the trip (for any reason). Then ask another collection of travelers how much they would pay for insurance that pays the same in the event of death from a terrorist act (and only a terrorist act). Guess which one would command a higher price? Odds are that people would rather pay for the second policy (although the former includes death from terrorism). The psychologists Daniel Kahneman and Amos Tversky figured this out several decades ago. The irony is that one of the sampled populations did not include people on the street, but professional predictors attending some society of forecasters’ annual meeting. In a now famous experiment they found that the majority of people, whether predictors or nonpredictors, will judge a deadly flood (causing thousands of deaths) caused by a California earthquake to be more likely than fatal flood (causing thousands of deaths) occurring somewhere in North America (which happens to include California). As a derivatives trader I noticed that people do not like to insure against something abstract; the risk that merits their attention is always something vivid.
This brings us to a more dangerous dimension of journalism. We just saw how the scientifically hideous George Will and his colleagues can twist arguments to sound right without being right. But there is a more general impact by information providers in biasing the presentation of the world one gets from the delivered information. It is a fact that our brain tends to go for superficial clues when it comes to risk and probability, these include being largely determined by what emotions they elicit or the ease with which they come to mind. In addition to such problems with the perception of risk, it is also scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.
In that sense the depiction coming from journalism is certainly not just an unrealistic representation of the world but rather the one that can fool you the most by grabbing your attention via your emotional apparatus – the cheapest to deliver sensation. Take the mad cow “threat” for example: Over a decade of hype, it only killed people (in the highest estimates) in the hundreds as compared to car accidents (several hundred thousands!) — except that the journalistic description of the latter would not be commercially fruitful. (Note that the risk of dying from food poisoning or in a car accident on the way to a restaurant is greater than dying from mad cow disease.) This sensationalism can divert empathy toward wrong causes: cancer and malnutrition being the ones that suffer the most from the lack of such attention. Malnutrition in Africa and Southeast Asia no longer causes the emotional impact — so it literally dropped out of the picture. In that sense the mental probabilistic map in one’s mind is so geared toward the sensational that one would realize informational gains by dispensing with the news. Another example concerns the volatility of markets. In people’s minds lower prices are far more “volatile” than sharply higher moves. In addition, volatility seems to be determined not by the actual moves but by the tone of the media. The market movements in the eighteen months after September 11, 2001, were far smaller than the ones that we faced in the eighteen months prior — but somehow in the mind of investors they were very volatile. The discussions in the media of the “terrorist threats” magnified the effect of these market moves in people’s heads. This is one of the may reasons that journalism may be the greatest plague we face today — as the world becomes more and more complicated and our minds are trained for more and more simplification.
All great investors consider themselves contrarian investors. Rather than avoiding journalism and the mainstream media (as Taleb recommends in a post I wrote earlier), I think profitable trading ideas can be sourced by systematically analyzing the news and measuring investor sentiment. When investors become too negative on a company, that often is a good entry point.
One thing I tend to look for is analyzing how a stock reacts to unambiguously good or bad news. Stocks should act as you expect — positive returns in response to positive news and negative returns in response to negative news. It’s when this relationship doesn’t hold that presents interesting opportunities. An anecdotal example: Several days ago, the latest industry reports stated that Research in Motion’s smartphone market share has declined again. Yet the stock price barely declined as a result. The interpretation is clear — this particular piece of bad news has already been priced into the stock. Buying at this entry point would have resulted in a quick 20 percent return.
Interested readers can buy Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets on Amazon.