Trade the Congressional Effect: How To Profit from Congress's Impact on the Stock Market

Summary

Concepts of behavioral finance are important in understanding that even though we aspire to be completely rational in our investment decision making, we actually make investment decisions that have a great deal of emotional bias that is reflected in how the stock market actually works and how investors actually view their returns. Behavioral finance teaches us to calibrate our reasoning so our biases do not undermine our investing success. For example, we tend to start with the information that is most readily available such as recent stock prices or headline news. When we get too much information, we shut down our decision-making process and prejudge data in a variety of ways. Behavioral finance is also particularly useful for understanding how Congress organizes its activities. Congress acts in an illogical and short-term-biased manner.

This brief overview of behavioral finance shows that in almost every major legislative decision, Congress explicitly or implicitly is driven by the self-interest of each congressman to do the opposite of what behavioral finance would suggest. It celebrates its biases by enacting laws that are premised on faulty logic and emotion, and has increasingly abandoned its foundational role of providing “cognitive reflection” in favor of procrastination, and favoring short-term fixes over long-term solutions. The Congressional Effect exists in no small part because every day millions of market participants and thousands of their fiduciaries watch ...