You’ve Been Framed

You’ve Been Framed

The study of behavioral finance defines framing as the tendency of decision-makers to respond to various situations differently based on the context in which a choice is presented. In many contexts, the decision maker is influenced by the manner in which the data is presented.

As an example, consider this headline from last week: “Dow Jones drops 832 points in third worst drop in history.” If you think this was an isolated news story, Google “third worst point decline in history.”

Factually, this is correct. However, points are not percentage. The 832-point decline was not even the largest THIS YEAR. While three percent declines don’t feel good, there were two such days in February. Consider the chart below which plots the 25 largest point declines in the history of the Dow Jones Industrial Average (right axis) and examines the percent change of that day (left axis).

Last week was volatile—there’s no denying that. However, it may have felt worse than it was. Part of the reason is that the summer months were calm. I wrote in July that the market was having a rather normal year in volatility terms. Then it went the entire third quarter without a +/- one percent daily move (70 days). The chart below shows the daily changes in the S&P 500 Index in 2018 (through October 12, 2018)

A suggestion to overcoming framing bias is to think objectively and focus on how the information is being presented. Getting the help of an adviser can have a significant impact. My suggestion is to stay away from financial media.

Data is sourced from Ycharts. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal.
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