Behavioural Finance

Synopsis on

THE ART OF CONTRARY THINKING

by Neil Humphrey

Submitted to
Prof. Suveera Gill

By
Hareetinder Kaur Gill
MBA-General-A (Semester-4)
 University Business School
Panjab University, Chandigarh
SYNOPSIS
Neil Humphrey in his classic book has piled on the evidence, citing forecasts that had gone
awry and historical examples of the madness of crowds. He liked to dig through old books
and share ideas from more obscure thinkers on crowd behavior, citing the work of Gustave
Le Bon and Gabriel Tarde and others. Most people are quick to conform and slow to differ.
Neill aimed to turn that around.

"When everybody thinks alike, everyone is likely to be wrong." The ten words quoted above
are, according to Humphrey B. Neill, a potent factor behind the economic booms and busts
that blight our civilization. The "Mississippi Bubble", Holland's incredible "Tulipmania" and
the New York stock market crash of 1929 are historic examples of disasters magnified and
hastened by the pressure of mass opinion.

In exactly the opposite direction, in the years immediately following the close of World War
II, ominous popular forecasts of business recession turned out to be wrong. What actually
happened was-a business boom, not a business bust!

The reason is no mystery to anyone versed in the contrary way of thought-the practical
application of the Neill Theory of Contrary Opinion. Today, this Theory-which began as one
man's quest for a way to solve the puzzles of economic trends-has expanded enormously in
both scope and significance.

Neill describes these occurrences in detail and tells the reader how to avoid and recognize the
dangers that "following the pack" can pose to the discerning investor.

In The Art Of Contrary Thinking, one will find the answer to a question increasingly asked by
persons of affairs and influence: Contrary Opinion-what is it?. . .What will it do for me?

If we had to distil the entire book to just one phrase, it would be Humphrey Bancroft Neills
own:

The crowd is most enthusiastic and optimistic when it should be cautious and prudent; and

is most fearful when it should be bold.

One can truly make a key piece of ones reallocation efforts based upon those few simple
words. Many authors have been featured in this series that recognized the value of
understanding investor psychology. Thats because understanding and evaluating for yourself
the sentiment of the crowd is key to successful investing.

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 The primary premise of the book is stated quite clearly in the first few pages: Human
behavior is fully as important as, if not more important than, statistical behavior." Mr. Neill
goes on, in ensuing essays, to talk about not just that popular opinions are often wrong, but
why this is so. The historical examples he provides are further reminders that this time its
different is a hollow phrase uttered by those who do not study history and are therefore
doomed to repeat it. And, the genius of this book lies in the quiet insights and pieces of
market wisdom spread randomly therein. This book gives a reflective read of Humphrey
Neills views on the value of patience, the assessment of risk, and the importance of asking
why? at regular intervals during the investment process. Prompt oneself with this question
regularly and one will become a better investor.

In as much as it is impossible to accurately time the reactions of the crowd, it is

advantageous to consider the opposite of what appears probable. The crowd has been so
wrong so frequently in their opinionsthat it is imperative to look on the unsuspected side of
all questions and all predictions.

Neil states that if one wishes to keep from guessing wrong, learn to think contrarily. This can
be done by training ones mind to think opposite to the herd and one will be right more often
than wrong. Crowd thinks with its heart while an individual thinks with his brain and when
these individuals are grouped together as a crowd, they lose their balance and act according to
the group.

The art of contrary thinking consists in training your mind to ruminate in directions opposite
to general public opinions; but weigh your conclusions in the light of current events and
current manifestations of human behavior. it is merely a matter of getting into the habit of
looking on both sides of all questions and then determining from your two-sided thinking
which is the more likely to be the correct versionwhich in turn leads to the correct
conclusion.

The object of contrary thinking is to challenge generally accepted viewpoints on the

prevailing trends in politics, socio-economics, business and stock markets. Opinions react
sharp as peoples emotions- their hopes, fears and passions- sway back and forth. In sum, the
purpose is to contest the popular view, because popular opinions are so frequently found to be
untimely, misled by propaganda, or plainly wrong. The method is to compel thinking and
observation in place of conclusion-hopping and snap guessing. The premise is that alternative
ideas make for a clearer, better defined judgement. Thus, contrarians need to be cynical and
the only defence against the opinion makers is to doubt all before you believe anything.

Neils theory is based upon laws of social and psychology among which these are logically
related, i.e.

i. A crowd yields to instincts which an individual acting alone suppresses.

ii. Herd characteristics make people follow group impulses instinctively.
iii. Emotional motivation makes people in a crowd more susceptible to hope, fear and
greed.
iv. Obsessions of the herd are substituted for sane, individual reflections.

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Thus Neils experience can be summed up as firstly, individual opinions are of little value
because so frequently wrong. Secondly, human traits (of fear, hope, greed, pride-of-opinion,
wishful thinking) are so strong that they prevent one from being objective. Thirdly, No trait is
stronger than that of defending ones opinion and of being unwilling to admit error in
judgment. Further, Neil stated that when all forecasters agree, that is the time to watch out.

Gustave Le Bon, Frenchman, has explained the actions of the crowds and how the crowd
reacts to various influences i.e. how crowd is susceptible to contagion. He explains that in
stock market, crowd is attracted to fluctuating movement of the prices especially rising
prices. Thus a crowd can be easily tempted into the market by a manipulator who has made a
stock active and pushed its prices higher. The power of suggestions motivates the actions of
the crowd. Even politicians like Mr. Truman has studied how crowd psychology works and
knows that crowd can be moved and impressed by excessive sentiments like exaggeration,
affirmation, repetition and by not proving anything by reasoning of arguments.

Mr. A. Wilfred May, executive editor of the Commercial and Financial Chronicle blasted the
popularity of market swing forecasting and punched out a strong case for the value
concept. Crowd is always wrong at important reversal areas in the market trends as the
average investor does not think and does not wish to think. Thus they follow the forecasting
which require no hard work and sweating. Mr. May states that a probing mind is a contrary
mind. Values are seldom unearthed except by looking in the less likely spots for the
unexploited medium. Contrarywise, the overvalued medium is overlooked when markets are
cheerful and everyone is buying..

Neil also states that crowd is right during the trends but is usually wrong at junctures of the
events and at terminal of the trends i.e. usually when it pays to be contrary. Further, the
contrary opinion will frequently result in ones being rather too far ahead of events or crowd
and it will seldom time ones conclusions accurately. This is because economic trends often
are very slow in turning or reversing.

Some of the historic events to review where contrary thinking could have made a difference
include tulipmania, south sea bubble, John Laws Mississippi Bubble, Charles Ponzi borrow
from Peter to pay Paul scheme in Boston, Florida Land Boom in the 1920s when the public
lots which were under water in back country Florida, , Japan in the 80s, Dot Com Boom,
Federal Inmate 61727-054 etc. During the 2008 Housing Crisis, markets suffered a lot. As the
market went down, the equity markets crashed. Most of the investors starting throwing in
their money in Bonds, as it is considered to be safe option, with a set return on the money. .
They were thinking bonds are safe, because you cannot loose money in bonds. and everybody
went to bond funds and they abandoned equity. But when they abandoned equities, no one
was there to take the benefits of the rise in equities , nobody was really there to benefit from
the price increase. This was where the smart investors used the theory of contrary thinking
and instead of going with the Herd, questioned What is gonna happen if everybody invest in
Bond funds, and waited to Book profits in Equity markets. As the equity markets rose later on
, the Contrarian investors were the people who gained benefits from the rise in equity, unlike

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the other investors who invested in the safe bonds. When other people were selling low, the
smart investors were buying at low prices to sell it at a higher price.

In 1634, one of the most extraordinary public manias took place in Holland
namedTulipmania. Prices of tulips reached great heights and this demand for tulips
speculation caused the rare species to be traded in on stock exchange of Amsterdam and other
dutch cities. The crowds believed that craze for tulips will last forever and wealthy from all
over the world would send to Holland and pay whatever prices were asked to get tulips. Soon
everyone began to deal in bulbs, essentially speculating on the tulip market, which was
believed to have no limits. The true bulb buyers began to fill up inventories for the growing
season, depleting the supply further and increasing scarcity and demand. Soon, prices were
rising so fast and high that people were trading their land, life savings, and anything else they
could liquidate to get more tulip bulbs. Needless to say, the prices were not an accurate
reflection of the value of a tulip bulb. Some prudent people decided to sell and crystallize
their profits. A domino effect of progressively lower and lower prices took place as everyone
tried to sell while not many were buying, thus leading to depression. This states the Le Bon
theory that if an idea attracts a few people, it is likely to spread and soon attract number of
crowds or everybody. As crowd does not think and acts on impulses, public opinion is
considered to be generally wrong.

Another such mania is South Sea Bubble in the early 18th century involving the shares of the
South Sea Company. When investors recognized the potential profits to be made from trade
with the gold and silver-rich South American colonies, they bid the South Sea Companys
shares and the shares of similar trading companies to incredible heights in a typical
speculative bubble fashion. Not long after virtually all classes of British society were
thoroughly engaged in wild stock speculation, the South Sea Bubble popped and stock prices
violently collapsed, financially ruining their investors. The huge hole in the south sea bubble
also punctured the Mississippi Company's unrealistic value and both came crashing down.
The Laws of Contrary thinking state that question everything and do not take anything at face
value. The same holds true in the South Sea Bubble as well , people invested for the face
value of the company and did not pay any heed to the firm`s actual working and the state of
daily operations, which would have painted a diametrically opposite picture , from an
investor`s perspective.

Thus Neils theory of Contrary Thinking can be concluded by stating that it is contrary to
ones natural reactions to be contrary to general opinions and others with whom one discusses
their contrary opinion will mostly violently disagree. Thus it becomes difficult to stick to
ones contrary viewpoint and it takes long time to prove the contrary view, which weakens
ones faith and leads to self doubt. Thus to be contrary one has to oppose the obvious and this
can be quite baffling. But contrary thinking unquestionably helps one to avoid many common
errors in forecasting arising out of miscalculations that public will do.