There is a pervasive myth in the investment-management industry that there is a select group of highly successful fund managers who have the rare quality of intuition, either as a fortunate gift or as a developed skill. They seem to be able to act without knowing exactly why they act, an almost magical ability that comes from the gut, or from grace, or some other mysterious place.
Herbert Simon, cognitive psychologist and winner of the Nobel prize in economics, wrote that there is in fact nothing magical about intuition, that intuition is “nothing more and nothing less than recognition”, where you recognise certain cues and then retrieve from memory the relevant experiences. This equation is dependent on the manner in which experiences are encoded in memory, which is to say that the development of valid intuition is dependent on the quality of feedback. The highest quality feedback is immediate and unambiguous, where there is a clear relationship between cause and effect (Michael Mauboussin, Think Twice). This feedback gives you the opportunity to learn, practice and improve, like the tennis pro who becomes ever more skillful at returning serve as she develops the ability to quickly pick up the trajectory of the ball and get her feet into the best position through many hours of work on the practice court with her coach. In some domains, intuition is valid: it can be developed and it can be trusted.
The worlds of the professional tennis player and the professional fund manager are not alike. Feedback from the markets to the fund manager is lagged and ambiguous, there is little in the way of a clear relationship between cause and effect, between action and outcome, despite the efforts of many financial journalists to invoke linear causality. In a word, financial markets are noisy. This means that it is questionable whether this domain affords the fund manager the opportunity to develop valid intuition. In some domains, especially financial markets, intuition has low validity and should be treated with scepticism.
There are two ways that fund managers can get lured into relying on intuition when they shouldn’t: through an experience of physical or mental ease, and through a sense of confidence.
From a neurobiological perspective, when the physical tension that arises as part of the fight/flight reaction is discharged through instinctive action, the human organism returns to a state of homeostasis. The absence of excess tension in this state of equilibrium is a pleasant and desirable state, experienced as relative ease or relief. This is an instinctive experience but it is wrongly considered to be intuitive because it feels right. Instinct and intuition are different things: the former is innate and requires no learning, like a baby’s startle response, while the latter is learned through high-quality feedback. It’s easy to mistake instinct for intuition but to do so can be a grave error.
From a psychological perspective, engaging in strenuous thought is effortful and unpleasant to human cognitive misers, and when this way of thinking is bypassed in favour of a reliance on heuristics it is accompanied by a desirable experience of relative ease or relief. The reliance on heuristics is characterised by the absence of effort. We mistake this sense of ease for what is right or best in the circumstances, and we convince ourselves that our experience of ease is really intuition because it feels right. This can be a serious mistake in financial markets. Mostly, what we believe to be intuition in this domain is merely a false simplification of a complex problem.
Daniel Kahneman makes the point that confidence in intuition is no guide to the validity of intuition. As fund managers gain experience they usually become more skilled in a variety of ways, and as their skill increases so does their confidence in their set of skills, of which intuition is often assumed to be a part. But it is most likely that financial-market intuition is not part of the fund manager’s skill set because the domain does not provide sufficiently good feedback in order for reliable intuition to be developed. Ironically, as fund managers’ experience and confidence grow, so does the risk that they will rely on unreliable intuition.
That said, clearly there are fund managers who do have higher quality cognitive machinery than the industry average. Some of these fortunate folk have also put in the many diligent hours required to evolve to a higher intellectual plane than even those who are merely very smart. These fund managers are able to engage in more complex and subtle second-order thinking than the simpler linear thinking that still dominates the industry. This level of cognition looks magical to the mere mortal and can easily be mistaken for intuition, but it is really just better-quality thinking.
- Under what conditions (low noise or high noise) do you tend to rely on intuition?
- To what degree is this accompanied by a sense of ease? What might that tell you?
- How might you immunise yourself against relying on unreliable intuition?