Keynes, His Beauty Contest, and How Mental Models Help Reduce Trading and Investing Complexity.

It does not matter what the analysis, fundamental news or evidence suggests, in the short-term, it is always the weight of buyers and sellers, and their positioning, that determines where markets head.

One person who understood this perfectly well, but only after struggling in the markets for a few years, was John Maynard Keynes.

Keynes realised that markets rarely conform to what appear to be ‘the facts’, but rather it is human emotions that drive markets.

He used the term "animal spirits" to describe how human emotions drives crowd behaviour and markets.

Keynes the failed but ultimately successful fund manager

Keynes' own experiences as an investor were a key factor in helping him come to these conclusions.

He had been responsible for managing the endowment fund of King's College at Cambridge.

His early experiences as a 'fund manger' were less than impressive.

From 1924 to 1932 he only marginally outperformed the under-performing UK stock market.

This was despite Keynes being the most informed person on the entire planet on anything and everything macro-economic.

Post-1932 however, Keynes's investment record was a different story.

The table below is reproduced from a Wall Street Journal article



Keynes the first Value Investor!!

From 1933 onward, Keynes abandoned his practice of looking at the big macro factors to help determine value.

It was during this time that Keynes became the pioneer of what was to become known as 'Value Investing'.

He had come to believe that truth based on objective assessment of data, was less important than trying to understand what 'moved' people to value an asset.

If he could understand people's motivations for valuing an asset, then he could improve how he picks stocks.

Keynes thus adopted a bottom-up ‘value’ approach to stock selection, though of of course macro-economic top-down was always improtant context. - In effect Keynes became the world's first 'value investor'.

The Keynesian Beauty Contest

To help describe his approach, Keynes came up with the concept of the 'Keynesian Beauty Contest'.

Keynes compared selecting investments to the way people made choices in newspaper beauty contests.

These contests involved Newspapers publishing photos of hundreds of beautiful women.

They would then ask readers to send in their opinions of which women were the most beautiful.

The reader whose choices most closely matched the six most popularly selected women, would win a prize.

Keynes wrote:

“It is not a case of choosing those (faces) which, to the best of one’s judgment, are really the prettiest, nor even those which average opinions genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be."

In other words, you could win the context if you could correctly guess what every one else thought, not what you alone thought.

Keynes 'Beauty Contest' concept was in effect a mental model.

Financial Markets as Complex Systems.

You can have the greatest brain and best information in the world, but the most important thing is understanding how markets work, then creating models which helps you monetise that.

The early investing experiences of Keynes demonstrated this. In effect, his Keynsian Beauty Contest concept was a 'mental model' that Keynes had created.

Mental models help one to make sense of the world, they enable us to reduce complexity and filter out noise.

All our perceptions are based on mental models. What we see through our eyes is not an actual representation of reality, but a filtered version.

It is all too easy confuse more knowledge with better knowledge. This is the fallacy which leads many people to think they can predict what will happen next. 

It is unnerving for many who enter the field of trading and investment to think it is not a science but an art. It's underpinning's may be scientific, but prediction and trading are very much an art. This is we talk about great traders being masters of the best guess.

Two centuries earlier, another British academic giant, whose status dwarfs even that of Keynes, was to suffer a more dramatic fate.

Isaac Newton having lost almost his entire fortune in the South Sea bubble, is reported to have said, 'I can calculate the motion of heavenly bodies, but not the madness of people'.

Article by Steven Goldstein

Steven Goldstein is a Performance, Team and Executive Coach who focuses on helping improve the 'mindset' aspects of Risk and Financial Markets' people and businesses.

Core to Steven's work is the belief that everyone has the potential, often latent or hidden within them, to surpass where they are and to grow into what they want to be. He views trading as two concurrent battles, one a person has with the markets and one they have with their self. To succeed a person must win both. As a coach, Steven works predominantly on helping his clients win the battle with their self.  

Prior to becoming a coach Steven worked for more than 20 years as a Rates and FX trader at some of the world’s leading investment banks. See Steven's Full Profile.

If you are curious about how Steven could help you or your business, please email him at info@alpharcubed.com. or call +44 (0)7753 446097. 

To know more about the work of AlphaRCubed and their broader performance and growth development services, please view their brochure at this link, or by clicking on the advert below. 

About AlphaMind

AlphaMind is a joint venture between AlphaRCubed and the Mark Randall Consultancy which seeks to help people develop and cultivate optimum mindsets (An Alpha Mindset) for trading and investing success. We offer workshops, group development programmes, and one-to-one coaching to people and individuals in Financial & Commodity Markets

AlphaRCubed offers Trading & Investing Growth Performance and Development Services for private indivudals and businesses involved in trading and investing activities. You can learn more about AlphaRCubed in their electronic brochure here, or via their website.

Mark Randall Consultancy offers Mindfulness based trading and coaching to people and businesses involved in Trading & Investing and beyond in the wider corporate space. MRC's unique and powerful outcome driven approach is aligned to the US Special Forces “Ultimate Warrior” Mindfitness training programme and is applied to the corporate workspace.

Subscribe to the upcoming 'AlphaMind' Newsletter at this link.

Join the AlphaMind Linkedin Group.

Follow us on Twitter and Instagram