Thursday , 23 May 2024

"Extraordinary Popular Delusions and the Madness of Crowds": A Review of the Best Book Ever Written On Market Psychology

Books can teach us more about human nature, investing, and wealth and risk management than any [life experiences] and this book is more than a book on intelligent investing – it is really a classic in critical thinking. Anyone can learn how to read a chart or throw bones into a circle, but this book will teach you about human psychology. That is how you beat the market, since it is always a marketplace of humans motivated by fear, greed, hope, arrogance and all the other human emotions, good and ill. Words: 1086

Lorimer Wilson, editor of, provides below further reformatted and edited [..] excerpts from Joseph Shaefer’s ( original review* for the sake of clarity and brevity to ensure a fast and easy read. Shaefer goes on to say:

You may be excused for wondering what a book published 169 years ago could possibly teach you about today’s markets. Not only had CDS’s and sub-prime mortgages not been invented, but in most parts of the world stock markets themselves had not yet been invented! Never forget though, that financial markets are subject to, sometimes dependent upon, and often ruled by, the whims of human nature. Human nature is as timeless as the stories from the Bible, the Torah, the Koran, the I Ching and every other compendium handed down orally until finally set down on leather, papyrus, or paper – and no one has described the follies of humans more cogently than Charles Mackay in 1841.

‘Extraordinary Popular Delusions and the Madness of Crowds’ includes case histories–long before case histories became a standard teaching tool–of three infamous financial manias.

1. The Tulip Mania
Tulip mania was a financial bubble in the 1620s and 1630s in Holland when contract prices for tulip bulbs reached amazingly high levels before collapsing. At the height of tulip mania in February 1637, a single tulip contract sold for more than 10 times the annual income of a skilled craftsman. Then it all fell apart.

2. The Mississippi Scheme
John Law’s early 1700s Mississippi Scheme, foisted by a Scottish economist mostly upon his French neighbors, in which the “untold wealth” of “Louisiana” (what the French called America and the Caribbean) was to pay off in no time at all. The excitement was so great that he issued considerably more paper shares than there was money in the Banque Generale Privee, at that time effectively the central bank of France — which he was head of — and which was effectively the guarantor of all that paper.

3. The South Sea Company
The South Sea Company was established on the British side of The Channel about the same time. It was granted a monopoly to trade in Spain’s Central and South American colonies as part of a treaty after the War of Spanish Succession. In return, the company assumed the entire national debt England had incurred during that war. The shortcoming that no one seemed to grasp was that, as part of the treaty with Spain, the South Sea Company was allowed to send only one trading ship per year to Spain’s American colonies! Still, people in that heavily class-conscious society, from the lowest to the highest, threw money at the venture as the company employed “the most extravagant rumours” to pump the share price from 100 Pounds to 1,000 Pounds in less than a year. All lost except those within the government and the nobles who had never really paid for their shares but were invited to accept shares in exchange for the use of their august names.

The Benefit of Hindsight
You cannot understand the dot-com phenomenon or the real estate bust nearly as readily without studying how it’s all happened before. Remember, nearly $1 and ½ trillion was invested in Internet stocks by some of the savviest investors in the world. When it was all said and done, that trillion and a half had been reduced to less than $100 billion. We all lived through it although some of us were fortunate to have sidestepped it, perhaps in part because we had once read ‘Extraordinary Popular Delusions and the Madness of Crowds’.

By understanding the patterns of greed and hope, and the ready willingness of charlatans to step forward to give us what we want, we might avoid the pitfalls that inevitably follow. If you understand that when someone utters the words, “This time it’s different” you are in the end-stages of a popular mania and can extricate yourself and save your entire fortune. I’m guessing that the rank-and-file Enron employees, who sunk their entire life savings into Enron stock, wish they would have done so.

What I take for action from this re-reading of ‘Extraordinary Popular Delusions and the Madness of Crowds’ is that the “prevailing wisdom” is less about wisdom than it is the prevailing combination of hopes, fears, greed, arrogance, wishes and prayers that enough people fervently want to believe in. It is also that man is a social animal influenced by others in his social, business, personal, reading, or Internet-surfing circle – a circle he defines based upon his own biases, upbringing, prejudices, experience, and the comments and approbation or criticism from those around him.

Reality – Then and Now
1. 1929
In 1929, many years after Mackay wrote this little gem, that combination of hopes, fears, wishes and prayers that enough people fervently want to believe in led them to believe they were on a permanently high plateau from which companies could never fall.

2. 2000
In 2000, the same geist / sentiment prevailed in regards to dot-com companies. It was ‘The New Economy’, ‘A New Paradigm’, ‘The New Reality’.

3. 2006
In reality, however, it wasn’t any more than home prices, circa 2006, could never fall in San Francisco, Las Vegas, Miami or wherever the proponent of exponential growth wanted so fervently to believe in.

4. 2010
In 2010, when all those around me are investing as if there will never be another correction, retrenchment, or minor or major pullback, I am quite comfortable under-performing the market for the time being and sticking with high dividend-paying equities and bond funds with 1-3 year maximum maturities, while shorting US Treasuries.

* (Joseph Shaefer is author of the investment primer ‘Bringing Home the Gold’ and editor of Investor’s Edge®.)

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
Permission to reprint in whole or in part is gladly granted, provided full credit is given.
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