Socionomics

Socionomics is a theory of collective human behavior. Its key hypothesis is that changes in social mood produce changes in the character of social action, contrasting with the conventional assumption that social actions (events) determine the character of social mood. Socionomics further posits that social mood trends result from humans’ unconscious impulse to herd in contexts of uncertainty. Social mood is ultimately manifest in social activities, including those in the economic, financial, political and cultural realms.

The word "socionomics" was coined by Robert Prechter and explained in his book The Wave Principle of Human Social Behavior (1999). A market analyst and expositor of R.N. Elliott's Wave Principle, Prechter has been developing the idea since 1979:

[M]ass human psychology...is registering its changes in the barometer known as the DJIA. This idea helps to explain the cause of future events: changes in the mass emotional outlook. That’s what comes first....Increasingly optimistic people expand business; increasingly depressed people contract their businesses....Events do not shape the [mood] of the market; it is the [mood] behind the market that shape events.

The counter-intuitive premise of socionomics has gained attention in scholarly journals, books, and the popular press; at academic conferences; and in research funded by the National Science Foundation.

The socionomic model

The socionomic model of social causality posits four principles regarding self-organized, complex human systems:

1. In contexts of uncertainty, people share an unconscious impulse to herd which is manifested in social mood trends;
2. These social mood trends reflect self-similar fractal patterns and thus are predictable within a range of probabilities;
3. Endogenous processes (not exogenous causes) create these patterns of collective behavior; and
4. Social mood trends both cause and govern the character of social actions in financial markets, economic production, fashions, politics, climates for peace and war, and other domains.

By stipulating that social mood motivates social behavior, socionomics challenges the popular understanding of news events and their influence. Many academics and traders of the technical analysis school have long been skeptical that news events cause price moves in financial markets, pointing to research showing the absence of any such linkage. Prechter's socionomic analysis of the Enron accounting scandal and its aftermath, and its further treatment by mathematician John Casti, argues clearly that news is not a cause but a result.

Similar research and analysis

Several historians and theorists have described trends and changes in social mood, and the actions that follow. Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds was an early popular history of irrational social mood and action, chronicling phenomena such as witch hunts and financial bubbles:

In reading the history of nations, we find that....they have their whims and their peculiarities; their seasons of excitement and recklessness…millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.

Gustave Le Bon's The Crowd (1895) was among the first major works on collective psychology, while the British surgeon Wilfred Trotter popularized the "herd behavior" phrase in his book, The Instincts of the Herd in Peace and War (1916). Le Bon offered the earliest detailed description of human herding dynamics:

…the disappearance of the conscious personality, the predominance of the unconscious personality, the turning by means of suggestion and contagion of feelings and ideas in an identical direction, the tendency to immediately transform the suggested ideas into acts; these...are the principal characteristics of the individual forming part of a crowd.

In Group Psychology and the Analysis of the Ego (1921), Sigmund Freud agreed in part with Le Bon and Trotter’s theories, relating the herd instinct in humans to separation anxiety:

The individual feels incomplete if he is alone. The fear shown by small children would seem already to be an expression of this herd instinct. Opposition to the herd is as good as separation from it, and is therefore anxiously avoided....The herd instinct would appear to be something primary....

Among early economic theorists, A.C. Pigou cited “waves of optimism and pessimism” as a psychological factor behind the fluctuations in the business cycle. An early sociological treatise by Vilfredo Pareto includes his theory of "residues and derivations," which Parker and Prechter say is a precursor to socionomics:

[There are] similar ideas in socionomic theory about the relationship between unconscious instincts, mediated by the limbic system, and rationalizations for the resulting social behavior, which are cortically mediated. Pareto’s postulation of an innate human instinct toward “sociability” is related to the socionomic conceptualization of a herding impulse (Pareto called such instincts “residues”), while his concept of mental “derivations,” the methods by which people justify their behavior, is related to socionomic theory regarding the role of rationalization in financial behavior.

More recently, studies in neuroscience have shed light on the brain's role in collective behavior. Paul D. MacLean's triune brain theory proposes that the human brain comprises three distinct systems which function as one; the more primal of these control emotions and instinctual behaviors, such as herding:

Because of the untold number of individuals involved, it would be particularly important to understand the...neural factors at work in mass isopraxis of human beings, e.g., mass migrations that have occurred from time to time in the past; mass rallies; adoptions by millions of people of fads and fashions that may not only sweep a country overnight, but also jump oceans.

Since MacLean, modern neuroscientists such as Joseph LeDoux, while challenging some of MacLean’s findings, have generally confirmed the unconscious and evolutionary aspects of lower brain functions and their substantial power in impelling behavior.

From the wave principle to socionomics

Prechter says that socionomics expands upon the insight of R.N. Elliott’s model of the financial markets, namely that the collective buying and selling decisions of investors produce recognizable patterns of price movement (or waves). Prechter says that in turn, these patterns reflect crowd behavior:

In humans, an unconscious herding impulse impels social mood trends and changes that are specifically patterned according to a natural growth principle [that] is the engine of cultural expression and social action.

If stock market trends reflect social mood trends, the emotions associated with those trends must have other manifestations. An examination of the major areas of social mood expression where data are available shows that they do, as popular cultural trends peak and trough coincidentally with the stock market....

Prechter's correlation of cultural and economic trends appeared in his earliest writings (1969). His first detailed description of social mood as the engine of financial and cultural behavior dates from August 1985 and reached a national audience in the September 1985 cover article in Barron's, "Elvis, Frankenstein and Andy Warhol." Prechter said that the psychological import of sentiment indicators such as Wall Street's renowned "hemline indicator" is authentic and far larger in scope:

For the trend in stock prices is a reflection of popular moods within the investment community, and by extension, within society at large....Trends in music, movies, fashion, literature, television, popular philosophy, sports, dance, automobile style, mores, sexual identity, family life, campus activities, politics and poetry, all reflect the prevailing mood of society.

This emphasis on the role of social mood was at odds with the "efficient markets" model, which was the defining view among economists and academics in the mid-1980s (and retains many supporters today). But the October 1987 stock market crash seemed inexplicable under standard financial models. A growing number of academics began to study and write about investor psychology in the developing field of behavioral finance. Yale economist Robert Shiller, for example, spoke of mood in his 1990 book, Market Volatility:

Investing in speculative assets is a social activity….It is thus plausible that investors' behavior (and hence prices of speculative assets) would be influenced by social mood. Attitudes or fashions seem to fluctuate in many other popular topics of conversation, such as food, clothing, health, or politics. These fluctuations often occur widely in the population and often appear without any apparent logical reason. It is plausible that attitudes or fashions regarding investments would also change spontaneously....

In 2005, finance professor and socionomist John Nofsinger elaborated on the premise that mood regulates macroeconomic trends:

The optimism of rising social mood stimulates investment, hiring, and expansion. The emotions move to euphoria as social mood peaks. The peaking mood fosters risk seeking behavior and excesses….This part of the cycle can be associated with stock market bubbles and corporate mis-behavior. As the euphoria wears out, social mood begins to decline. Pessimism takes over. Lenders recall loans, corporate scandals are revealed, investors sell stocks, and companies layoff employees. The declining mood eventually bottoms…[which] sets the stage for the next rise in social mood and the next business cycle.

Criticism

The relative newness of socionomic theory means there are as yet few formal critiques available. One on-the-record critic is economist and Professor Emeritus Donald Ratajczak:

There is a dramatic amount of information available. If you use subsets of that information, you can almost create any picture. Are you using a model that captures whatever subset of all available information fits into your current category?…if that’s what you’re doing, then over time, you’re going to be eliminating relevant information, basically defining your own picture.

Geophysics Professor Didier Sornette said that the Ramsey Theory in mathematics

tells you that any sufficiently complex system will exhibit absolutely any pattern you want. For example, the naming of constellations in the sky. You have three thousand stars that are visible, and they show many types of patterns. You could recognize whatever pattern you want. Our brain has been wired due to evolution to recognize patterns very efficiently.

Author and technical analyst David Aronson wrote about socionomics,

Many of the brilliant theories of science began as half-backed prescientific ideas on the wrong side of the falsifiability criterion. These ideas needed time to develop, and some turned into meaningful science. One example in [technical analysis] is the new field of socionomics, an outgrowth of Elliott Wave Theory. At the current time, I regard this newly developing discipline as prescientific, though it may have the potential to become a science.

Current research

In June 2007, the Journal of Behavioral Finance published Prechter and Parker's paper, "The Financial/Economic Dichotomy in Social Behavioral Dynamics: The Socionomic Perspective."

File:JBF tbl2 png24a.png

From the Journal of Behavioral Finance.

The authors' socionomic theory of finance (STF) ranges from the individual neurological level to the behavior of societies. They argue that while economic principles such as the law of supply and demand apply in the market for utilitarian goods and services, a "law of patterned herding" applies in financial markets:

In finance, uncertainty about valuations by other homogeneous agents induces unconscious, non-rational herding, which follows endogenously regulated fluctuations in social mood, which in turn determine financial fluctuations.

While accepting economic theory in the economic realm, the authors challenge many conventional assertions about financial behavior, as shown in the table at the right from their paper.

References

• Robert R. Prechter, Jr., The Wave Principle of Human Social Behavior and the New Science of Socionomics (Reissued 2002), New Classics Library. ISBN 0-93-275054-0 (paperbound: ISBN 0-93-275049-4).
• Robert R. Prechter, Jr., Pioneering Studies In Socionomics (2003), New Classics Library. ISBN 0-93-275056-7.

See also

• Elliott wave principle
• Robert Prechter
• Herding behavior
• Behavioral finance
• Journal of Behavioral Finance
• Technical analysis