Learning from Cialdini Principles

——Review of Chapter 11 "All I Really Need to

Know I Learned at a Tupperware Party "

Abstract: Based on the theory of Robert Cialdini, Six Principles of Persuasion, this
article focuses on the influence of three of Cialdini’s six tendencies, consistency and
commitment, social validation, and scarcity, in the decision-making process of
investments.

1. Introduction
Robert Cialdini is known globally as the foundational expert in the science of
influence and how to apply it ethically in business. Dr. Cialdini has spent his entire
career researching the science of Influence, earning him an international reputation as
an expert in the fields of persuasion, compliance, and negotiation. Cialdini addresses
six psychological principles of influencing: Consistency and Commitment,
Reciprocation, Social Validation, Authority, Liking, and Scarcity. Each principle tends
to have a basis as a useful mental short cut which has evolved with human
development and aided society's functioning. His Six Principles of Persuasion have
become a cornerstone for any organization serious about effectively increasing their
influence.
When it comes to investing, understanding each of these fundamental principles can
provide invaluable insights. It can help people to have a better understanding about a
company's competitive advantage, why share prices may be acting in a particular way,
why a board has engaged in a certain manner or why shareholders or analysts have
taken a certain stand.

2. The Psychology of Investing

Mauboussin said that three of Cialdini’s six tendencies are particularly relevant for
investors: consistency and commitment, social validation, and scarcity. The following
content is going to discuss about the influence that those three tendencies exert to
investors.
Consistency and Commitment
Commitment and consistency is a psychological tendency that people have to always
ensure consistency between actions and inner values systems. People sometimes act
without thinking and abandon strongly held beliefs in order to stubbornly follow a
consistent path. As a consequence, commitment and consistency can sometimes lead
to undesirable behavior or outcomes because people are so determined to be
consistent that they avoid thinking about the negative result of their behavior.
For example, if an investor who has taken a position in a particular stock,
recommended it publicly, or encouraged colleagues to participate, will feel the need to
stick with the call. On one hand, investors would selectively receive subsequent news
about the stock because of the commitment tendency. They tended to accept more
favorable information about the stock and ignore some unfavorable information. On
the other hand, the consistency tendency can make investors lose some abilities to
thinking independently. This may harm the investment earnings.
Commitment and consistency is one of the rules about human conduct in Cialdini’s
research. The dangerous side-effect for investors of commitment and consistency
tendencies lies in situations that are changing or when there is contrary information to
our initial assumptions. Investors often don't change their minds when contradictory
evidence makes it obvious they should. Investors need to overcome these traps set by
human natural conduct.
For overcoming commitment bias, being a generalist allows you take a wider view of
the investment landscape rather than committing to a certain type of investment. By
refraining from publicly disclosing an investment idea there is less risk of becoming
committed to it.
What is more, Investors' investment strategies should rely more on scientific data
analysis instead of subjective judgment. When receiving relevant events about
investment portfolio, investors should scientifically analyze the probability of their
occurrence and the impact degree of each event. Investors need to embrace diversity
of views and keep the critical thinking. They need to fully consider some extreme
situations and make their own unique investment strategies. However, in our view, the
consistency may reduce risks in many situations. After all, mainstream analysis deals
with events with high probability, an investment strategy that follows the prevailing
view is likely to be more robust.
Getting others to continually test your ideas can help force you to consider alternative
theses and help avoid investment mistakes. Writing an investment strategies prior to
investing and then regularly re-checking your reasons can help you maintain an
unbiased and rational view should developments evolve contrary to your original
expectations. Simply asking yourself if you'd buy the stock today if you didn't own it
is another good self-check.
Remaining flexible, keeping an open-mind and maintaining a sense of humility is
essential. Recognize there are things you can't know. Recognize that you will make
mistakes. And when you enter an investment, acknowledge you may be wrong and
you'll be far better placed to adjust your portfolios if and when required.

Social Validation
Social validation refers to the tendency of people to follow the actions of others when
making decisions, placing weight on these actions to assume the correct decision. We
are all social animals and we conduct ourselves in a manner that fits in with others.
Generally, in everyday life we make fewer mistakes by acting in accord with social
evidence than contrary to it. We can also see in investment behavior that investor
prefer to follow the popular choice: When everyone is bullish on a company's stock at
the same time, we can easily assume that the stock will definitely go up and buy it in
large quantities. Similarly, when there is negative news about the stock at a certain
time, we will panic and sell in large numbers. People are always swayed by irrational
voices and make decisions.
Conversely, sometimes the social validation effect does not always work in the stock
market. The "I'm greedy when others are fearful, and I'm fearful when others are
greedy" principle that has been adopted by later generations of value investors can
sometimes be more profitable for us. This is what the old stockbrokers used to call a
squeeze, a washout. When you find a stock that is undervalued through your own in-
depth thinking and analysis, buying it immediately does not usually produce
immediate profits. The stock will spend a long time fluctuating sideways repeatedly
within a narrow range, not even ruling out an inexplicable dive to dig a hole before it
starts. It is usually at this time that all sorts of negative talk come out of the market.
Faced with losses and rumors, most stockholders, except for a very few exceptionally
determined investors, will sell their stocks at the bottom or at the beginning of a
reversal, choosing to succumb to the irrational voices in the market. This is when the
"holder" tends to gain more. Public market opportunities have a tendency to be
contrarian and therefore can make us feel uncomfortable and lonely. For investors, it's
a conscious choice; to blindly follow the loudest voices or the biggest crowds, or to
actively choose to go on your own, independent path.

Scarcity
It is no surprise that people want more of those things they can have less of. Most new
offerings are done in a manner where the idea is to have far more demand than supply,
and therefore cause people to order stock they didn’t even want, and just on the idea
that this restricted supply will cause a big jump the first day.
Economically speaking, scarcity directly determines commodity prices, while long-
term commodity prices determine the value of an enterprise's investment. Therefore,
the value of a firm's investment depends on the scarcity of the goods that the firm
produces. Investors in particular seek informational scarcity. The challenge is to
distinguish between what is truly scarce information and what is not.
On the other hand, Scarcity stems in large part from a cognitive bias called loss
aversion, where people's subjective perceptions of value loss are greater than those of
value gain, so people have a strong desire to avoid losses rather than gain. In layman's
terms, the pain of losing $100 is considered greater than the joy of gaining $100. The
psychology of avoiding loss explains the effectiveness of scarcity, and if people don't
act on scarce products or information, they think they are going to lose them. It’s the
reason that most investors fail to cut losing trades and also a reason investor can be
wrong-footed when faced with portfolio losses.
One method for not letting loss aversion trip you up is to take a longer-term view. The
stock you own is just a business, and the share price will reflect earnings over the long
term. Prices don’t always equate with value, so monitor the business performance and
understand the stock price contains less useful information. Given short term stock
movements are largely random, checking the portfolio less frequently can also help. If
you don’t check your portfolio every day, you will be spared the angst of watching
daily price gyrations; the longer you hold off, the less you will be confronted with
volatility and therefore the more attractive your choices seem. Put differently, the two
factors that contribute to an investor’s unwillingness to bear the risks of holding
stocks are loss aversion and a frequent evaluation period.

3. Conclusion
Investors are not always rational, have limits to their self-control and are influenced
by their own biases. It is important to know how the influence of psychology on the
behavior of investors affect us in the investment, which leads to behavioral finance,
the study proposes that psychological influences and biases affect the financial
behaviors of investors.
Behavioral finance helps us understand how financial decisions around things like
investments, payments, risk, and personal debt, are greatly influenced by human
emotion, biases, and cognitive limitations of the mind in processing and responding to
information. By understanding how and when people deviate from rational
expectations, will help us make better, more rational decisions when it comes to
investments.
By acting more or less "irrationally", investors might fall victim to a series of
cognitive, emotional, and social forces that lead them to make sub-optimal decisions
and undermine their performance in the markets and elsewhere. By knowing these
limitations of human behavior and decision-making, investors can make corrections
or adjust for them. It also implies that markets are not as efficient as standard theory
predicts, leaving room for investors to take advantage of mispricing and earn a profit.
As a conclusion, investors can be their own worst enemies. Trying to out-guess the
market doesn't pay off over the long term. In fact, it often results in quirky, irrational
behavior, not to mention a dent in your wealth. Implementing a strategy that is well
thought out and sticking to it may help investors avoid many of these common
investing mistakes.