John Allen Paulos [JP] is a mathematician who has written fantastic popular science books on mathematics, which I wholeheartedly recommend. If you find any of them, read them. You won't regret it. In the 1990s, JP was one of the many victims of the dot-com bubble. His experience of being nearly ruined led him to write this book, in which he provides an impressive overview of the stock market, its workings, and the mathematical intricacies underlying stock prices and investment strategies.
JP writes very well. The concepts he explains are sometimes very, very complex, and yet he manages to pull them off every time. I admire him immensely. Furthermore, he chooses topics that I personally find very interesting. He has it all.
In the book, we learn about concepts like the anchoring effect, which is truly surprising: Imagine an experiment in which we are asked for a number we don't know. For example, the population of Uzbekistan. Initially, we don't know what to say, but then the examiner says: "Okay, is it more or less than 100 million?" The examiner asks another group the same question, but instead of saying 100 million, he says 1 million. The average answer for the people to whom the examiner suggested 100 million is around 60 million, while the average for those who received the suggestion of 1 million is around 5 million. In other words, we are influenced by one number when trying to estimate another.
One might argue that people were influenced by the experimenter's estimate because they assume he knows the answer and they don't, so based on his assumption, they gravitate toward what seems to be the correct answer. But no. The experiment was repeated, but instead of a suggestion from the experimenter, a roulette wheel was spun! The roulette wheel had numbers: 1 million, 5 million, 10 million, 50 million, 100 million The population of Uzbekistan was asked a question, and the wheel was spun. The average responses from each group were surprisingly close to the result that came up on the roulette wheel each time. Impressive. The same thing, says JP, happens when we buy stocks (or take out a variable-rate mortgage). If the stocks are priced at 60 euros when we buy them, we unconsciously take this value as the average of the stocks, so if they are above that price, they are good, and if they are below, they are bad. I took out my mortgage with the Euribor at around 2.1%, so now that it's at 4%, I see it as very high. However, looking at the Euribor over the last 20 years, I see that 4% is quite low (which both makes me uncomfortable and scares me).
Another issue: biases. We feel more guilty if we lose money due to action than due to inaction. In other words, if we buy something and the price drops, we'll feel worse than if we don't sell it and the price drops, even though the amount of money lost in each case will be the same.
