(noun, etymology Dutch from ‘boedel’: estate, possession, inheritance, stock.). 1. Crowd, pack, lot, as in ‘the whole boodle.’ 2. a. Counterfeit money b. Money acquired or spent illegally or improperly, particularly when used in bribery for political purposes. 3. Slang for money in general.

Stock Prices and the Social Nature of Money (Part I)

Posted on: Sep. 21, 2010  |  By: Ronnie Kahn  |  Category: General

A number of years ago, I was in Paris with my wife.  While making our way to the obligatory American tourist visit of Jim Morrison’s grave, we noticed a small restaurant that was absolutely packed with locals.  The wait would have been too long so we asked the maitre’d (in this case, it really was one) when would be a better time to come back and get a table.  He gave us an off-day and time.  We had to return to Paris at the end of our travels to fly home so we made a special point of going back to the restaurant.  It was nowhere near our hotel, but we just had to know what made the establishment so popular.

When we returned, in fact, there were very few people (or patrons) there.  We figured the maitre d’ knew his stuff.  After we finished the entrée (in this case it really was one), we couldn’t help but think that this place was totally overrated or something weird was going on.  We finally decided to ask why on this night the restaurant was so deserted, yet it was so crowded some days back.  The waiter thought back to the day in question, and he finally arrived at the answer which was that there was a private party that had a special event that night and pretty much took the whole place over.

I realize now that we got caught up in the social behavior known as herding.  In this case, it was herding based on an erroneous assumption that none of the parties at the restaurant knew each other and that is was so crowded because everyone was enamored with the place.  In any case, people love to do what others are doing.  We watch viral videos, sleeper hit movies, buy toys that everyone has to have, or adhere to the latest fashion craze.

Herding, in and of itself is not a bad thing.  It is what we do as social beings.  Sometimes we get it right, and sometimes we make large errors.  The errors are large because we are basing the choices we make on what others are doing and not some well thought-out decision.  If others get it wrong, then a whole throng of us get it wrong as well.  When a ton of people are making independent choices, things work out well, but when everyone starts to influence everyone else, we are just making choices based on what others are doing.

Prices themselves are a form of social interaction in that markets tend to come up with a price that a buyer wants to pay and at the same time a price the seller wants to receive.  In the case of financial markets, there are millions of these transactions which tend to adjust themselves fairly efficiently.  These choices are in most cases made independently and prices seem to work out well for a seller who wants to sell and a buyer motivated to buy.   For the seller, they have made a call that predicts whether they expect the price will go down in the future or feel the current price of the stock is not worth what will be paid in dividends and/or price appreciation.  For the buyer, the opposite is true in that they believe the price paid will justify the amount of dividends and/or price that the stock will reach down the road.

Most of us are familiar with how herding can affect stock prices.  If everyone is buying, the price rises, and vice versa.  These are just the rules of supply and demand.  Each investor has a threshold as to when they get in.  As the price goes up, more and more of us reach our threshold and join in.  Then the next group reaches their threshold and it begins to seem that this thing can only keep going up since so many of us can’t be wrong.  This type of herding is why we have bubbles, manias, and panics.  At the extreme of a mania, even the last threshold group doesn’t want to get left out.  A panic, though, has a very quick threshold as everyone gets out almost at once.  Then, a new threshold is reached when the stock reaches such a low price, new buyers find it attractive again and the process starts anew.

There may be another more insidious type of stock price effect due to our social nature.  We are highly emotional beings.  When everyone is in an optimistic frenzy, we tend to think everything will keep going up.  When everyone has just experienced a shock, such as the stock meltdown of 2008, fear and protection kicks in.  In the second part, we will examine how each person makes their decision on whether to buy or sell and how this has become skewed by the social nature of stock prices.

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