In my last article “Why do we invest in Shitcoins?“, you learned about System 1 and 2 of our mind. You were exposed to an experiment that showed how easily your mind is fooled by a simple illusion. With this newly gained knowledge, you understood how you can prevent investments in coins that later turn out to be shitcoins. In case you missed it, you can read it here to better understand part two.
Part one of this series rather focused on System 1 and how it is easily fooled. In part two “When do we invest in Shitcoins?“, we will talk more about System 2 which mainly monitors and controls thoughts and actions that are “suggested” by System 1 and in what situations you are most likely to make bad decisions.
To warm up, I would like to start with another experiment. Just listen to your intuition and do not try to solve the following puzzle:
A bat and ball cost $1.10.
The bat costs one dollar more than the ball.
How much does the ball cost?
You quickly came to an answer, which of course is 10¢. The reason why this easy puzzle is so special is that it evokes an answer that is intuitive, appealing, and wrong. If you would have actively checked whether your answer was correct or not, you would have noticed that if the ball costs 10¢, the total cost will be $1.20 (10¢ for the ball and $1.10 for the bat) and not $1.10. The correct answer is 5¢. Those who ended up with the correct answer probably intuitively started with 10¢ but somehow managed to resist this intuition. A few seconds of mental work could avoid an embarrassing mistake. If your answer was 10¢ then you probably follow the law of least effort. If you avoided that answer, you appear to have more active minds. This puzzle shows you that System 1 is impulsive and intuitive and System 2 is capable of reasoning but for some System 2 is also lazy (Kahneman, 2011).
The psychologist Roy Baumeister and his colleagues (1998) have shown that all variants of voluntary effort (cognitive, emotional, or physical) draw mental energy from a shared pool. They have repeatedly found that effort of will or self-control is tiring. This means that if you have to force yourself to do something, you are less willing or less able to exert self-control when the next challenge comes around. Baumeister et al. (1998) call this phenomenon ego depletion.
A rather disturbing demonstration of depletion effects in judgment was a study with eight parole judges in Israel. They spent entire days reviewing applications for parole. The judges had an average of 6 minutes per case and had three food breaks per day. The authors of the study plotted the proportion of the approved request against the time since the last food break. After each meal, the proportion spikes to about 65% of requests that are granted, dropping steadily during the next hours to about zero just before the next meal. After checking many alternative explanations, the best possible account for the data provides bad news: tired and hungry judges tend to fall back on the easier default position of denying requests for parole.
If you want to put our money into Cryptocurrencies, you can choose from over 2000 Cryptocurrencies that are currently traded (Coinmarketcap.com). The selection which Cryptocurrencies you want to buy will accelerate your cognitive resources. It will increase the ego depletion and this will cause a negative relation to self-control. You will end up buying more Cryptocurrencies than you initially would have if the Cryptocurrency universe were smaller. And since your System 2 is also lazy, you probably do not question your selection and may end up with some Shitcoins in your portfolio.
Let’s suppose you had to make a lot of decisions at work throughout the day. And then after work you want to invest in some Cryptocurrencies. What do you think: are you going to choose projects that are better long-term investments, or will you opt to choose the quick payoff? Experiments have shown that people that already had to make a lot of decisions, tend to opt for the quick payoff (because you are already ego depleted).
If you are an active trader and not an investor and you have been trading all day, maintaining the discipline to cut losses short will become decreasingly difficult. When you notice that closing down losing positions is becoming increasingly difficult, better take a break to avoid ego depletion influencing your performance.
It is probably best not to make financial decisions if you are in a state of ego depletion. Take a break, eat something and always do your own research (DYOR) before investing, even more so if you had a rough day with many decisions to make. And before you finally decide to buy a Cryptocurrency, also think of part one of this series to make sure your System 1 is not fooling you.
I hope you enjoyed this article and until next time with more!
References:
Baumeister, R. F., Bratslavsky, E., Muraven, M., & Tice, D. M. (1998). Ego depletion: Is the active self a limited resource? Journal of Personality and Social Psychology, 74(5), 1252-1265.
Kahneman, D. (2011). Thinking, Fast and Slow. Great Britain, Allen Lane.