WHERE IS THE BEST STOCKS?The mind is a truly miraculous machine. But it also has its flaws.

The mind is a truly miraculous machine. But it also has its flaws.

One of the most astounding "tricks" the human brain pulls off is giving each one of us the impression of seamless and complete reality. Very few people go around complaining about the giant, gaping holes in their visual spectrum � or in their memories. And yet the gaping holes are there.

The reason you never notice these holes (and why I don't notice them either) is because your brain "fills in the gaps" automatically. Much of what you see, and even more of what you remember, is actually a product of your imagination... an uncanny reconstructed version of events, based on your brain's split-second calculations of what the holes should be filled with.

This filling in of holes is a good thing, not a bad thing, and the mind is incredibly good at what it does. Whether we realize it or not � and mostly we don't � the brain pulls off amazing feats every day. Like assessing a negotiable gap in traffic, for instance, while merging onto a busy highway at 65 miles per hour. No robot on Earth can do that... yet we routinely do it while sipping hot coffee and fiddling with the radio.

 

The trouble comes when we forget that perception and reality are not the same thing. Arien Mack, an expert on cognitive psychology, observes that "Most people have the impression that they simply see what is there and do so merely by opening their eyes and looking." But all too often � and especially in markets � this really isn't the case at all.

The Invisible Gorilla

A famous experiment by a group of Harvard psychologists shows just how big the "holes" in human perception can be, especially when we are concentrating hard on a task.

As part of the experiment, the test subjects (who had no idea what was actually being tested) were shown a video. The video showed a group of basketball players, some of them in white uniforms and some of them in black uniforms, passing a basketball back and forth. The test subjects were also given a specific task � count the number of passes made by the team of white uniforms or the team of black uniforms.

So far, so good, right? Just a mental math exercise, really. Keep track of where the basketball is going and tally up the results. But here is where the experiment gets interesting.

In the middle of the video, while the teams are passing the basketball around, one of two things happened. Either a woman with an umbrella would walk into the center of the action, or, even more oddly, a person in a gorilla costume would do the same thing. In either case, the intruder � either the umbrella woman or the gorilla � would stay visible for roughly five seconds.

In truth, the Harvard psychologists didn't really care how many times the basketball was passed around or how well the test subjects could count. The task was a red herring, a simple means of getting the test subjects to concentrate.

The real answer the experimenters wanted answered was, How many of the test subjects would notice the woman with the umbrella? Better yet, How many of them would notice the gorilla?

"Did I notice the What?"

After the video finished, the psychologists asked the subjects if they noticed anything peculiar about what they just watched. This is where we see how just how powerfully tunnel vision can affect the brain.

Thirty-five percent of test subjects missed the woman with the umbrella. They just didn't see her at all. A whopping fifty-six percent failed to notice the gorilla.

When asked specifically of those who missed it, "Did you see anyone walk across the screen," the answer was no. Complete puzzlement. When asked point blank, "Did you notice the gorilla," they thought the question was a joke. Typical answer: "The what?"

Keep in mind, though, that the results were very different for those asked to count the passes versus those simply asked to watch a random video. It was specifically the group of test subjects who were busy tracking the basketball who missed the woman and the gorilla.

The act of sheer concentration required to tally the movements of the ball, and to keep track of the black and white uniforms, was enough to completely block out the perception of a man in ape suit, standing there, plain as day, for a full five seconds.

Market Blindness

The same type of "inattentional blindness" can happen in markets. In fact it happens all the time. The dangerous part of this equation comes from the fact that we don't register our lack of perception. We go on assuming that we see everything � not realizing that our brains have gotten overly focused on one small part of the picture, sometimes to such a degree that a gorilla could be standing in front of us and we wouldn't even notice.

Take the great housing bubble and bust for example. In primate analogy terms, the housing bubble wasn't so much a gorilla as full-blown King Kong. In hindsight, it would seem impossible to have missed such a thing. How could the country, and the world, have missed all the glaring signs?

We are harsh on the dirty tactics of Wall Street in these pages � and deservedly so � but the investment bankers missed it too. Bear Stearns and Lehman Brothers and the like would never have loaded up on toxic subprime paper to the degree that they did if they had had any inkling of what was coming. There is a difference between rampant greed and suicidal tendencies.

Or think of the millions of real estate investors who followed housing over a cliff. Why did they do it? Why did no one step back and say "whoa, wait a second" when we started seeing chest-beating gorilla phenomena pop up like "condoflip.com," complete with the charming slogan "bubbles are for bathtubs?"

The explanation for the bubble is multi-faceted � some of it having to do with concepts like greed, social peer pressure, internal corruption, lax monetary policy, and so on. But I also suspect that mass "tunnel vision" played a very big role.

To see what I mean, go back to the video experiment for a second. Imagine that you were one of the test subjects asked to count the basketball passes. Then further imagine that, with every additional pass that you counted, a big chunk of money would be added to your bank account.

Now your motivation to keep track of the basketball is even more powerful, because you perceive yourself as getting richer with every pass. If someone tried to bother you or disrupt your concentration in this state, you might even be tempted to snarl at them. "Leave me alone dammit, I'm making money here!" What are the chances you would have seen the gorilla in that scenario? Very slim.

 

Trading Takeaways

The first takeaway here is pretty obvious � beware of tunnel vision in markets.

You may think you're seeing everything, because that is precisely the impression that your functional human brain is supposed to deliver. But if you're too dialed in to just one small part of the picture, a gorilla could just about walk up and tap you on the shoulder and you might not even notice it.

The bigger takeaway is that invisible gorillas can help you make money... if you can get good at spotting them before the crowd does.

The crowd is epically bad at anything having to do with deep analysis or insight. This is because the majority of participants in the market crowd are "flying on automatic pilot to the land of groupthink," to use an old Doug Casey phrase, and another big chunk are passive and not really possessed with the drive to figure out what's going on. That leaves only a small handful of market participants to do the real thinking and observing.

And thus, when a gorilla walks into the room, most of the time the crowd won't notice it. They'll just keep pushing on in the general direction they were already going, or otherwise ignore the big opportunity � or the big risk � that the gorilla represents. This concept is very powerful because the crowd is not always wrong... but by definition, the crowd is wrong at major market turning points.

So how to get better at spotting gorillas? Work on "defocusing" your eyes every once in a while, as Taipan Daily reader LBT mentioned earlier this week. Take the time to step back and think about the big questions every so often. Brush up on market history. Look at long term charts as well as daily charts. Jointly exercise your creative and analytical side � make them play together. Ask yourself, What could I be missing? What have I been too biased or harried or distracted to see?

If you do this regularly, and work on it and get good at it, you'll get better at spotting gorillas as a natural habit � not just in markets but in day-to-day life, where unexpected insights have a special power of their own. In markets specifically, the reward for cultivating this open-minded habit is discovery of the occasional insight that could save you a heck of a lot of money... or make you a truckload of money... or both at the same time.