The Hindu Business Line : <I>Tomato effect</I>

My friend's neighbour is a doctor who dabbles in the stock market. Some time back, he got interested in technical analysis. After some initiation from my friend, he started following a few price patterns.

Despite enough evidence, my friend's neighbour found it difficult to accept that anybody could actually profit from reading such patterns.

He suffers from the "Tomato effect". What is this?

In the early 18th century, Americans considered the tomato poisonous despite the fact that Europeans consumed the red fruit and still lived to see another day. Two physicians borrowed this behaviour to the medical world and coined it the "Tomato effect". James Goodwin and Jean Goodwin found that people rejected treatment for certain diseases because it did not "make sense" in the light of the accepted theories of disease mechanism.

Take rheumatoid arthritis. At one time, it was believed that this disease was caused due to infection. A treatment using gold salts was, hence, administered. Later, the treatment was stopped despite its usefulness.

The reason? The belief that arthritis was caused due to infection was discredited. So, how could a treatment based on such a belief be correct?

All of us suffer from the Tomato Effect in our everyday life. You may, for instance, not listen to your spouse's intuitive investment advice.

You prefer to listen to your financial planner despite your spouse's advice turning out correct more often! How could your spouse know better than a trained financial planner you reason?

Similarly, my friend's neighbour had evidence to suggest that one can read price patterns and profit from it.

Yet, if stock prices are ruled by fundamentals, how can reading daily price patterns help, he reasoned? It just did not "make sense".

(The author is based in Ontario, Canada)

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