Practical analysis for investment professionals

The Intuitive Investor: Defining Intuition

The Intuitive Investor

In order to properly set the stage for additional discussion about the topic, it is important to first define intuition. Once we have a common understanding of what is meant by intuition, the benefits of cultivating intuition will become more obvious.

I think Daniel Kahneman sets intuition up as a straw man for his behavioral economics theories. In his well-received book Thinking, Fast and Slow, of which I am a fan, he associates intuition with “System 1” thinking, which, he says, is “fast thinking,” characterized by snap assessments of situations, subconscious thinking, and thoughts processed in the brain’s amygdala. Kahneman holds up “System 2” thinking as the opposite. It is “slow thinking,” characterized by deep analysis and processed in the prefrontal cortex.

I submit, however, that he associates the wrong word with System 1 thinking. It should not be intuition but instinct that is Kahneman’s descriptor for System 1 thinking. Kahneman himself seems to suggest this in his book, in which he says:

“The capabilities of System 1 include innate skills that we share with other animals. We are born prepared to perceive the world around us, recognize objects, orient attention, avoid losses, and fear spiders.”

In fact, no less an authority on the meaning of words than the Oxford English Dictionary (OED) defines instinct as follows:

  1. Instigation; impulse; prompting. Obs.
  2. Innate impulse; natural or spontaneous tendency or inclination. Formerly applicable to the natural tendencies of inanimate things. In modern use associated with sense.
  3. (a) spec. An innate propensity in organized beings (esp. in the lower animals), varying with the species, and manifesting itself in acts which appear to be rational, but are performed without conscious design or intentional adaptation of means to ends. Also, the faculty supposed to be involved in this operation (formerly often regarded as a kind of intuitive knowledge). (b) Any faculty acting like animal instinct; intuition; unconscious dexterity or skill.

First, note the near match between Kahneman’s definition of the word intuition with the OED’s definition of the word instinct. Note further that the OED relegates Kahneman’s interchangeable use of instinct and intuition to its final definition (i.e., 3b) and that immediately preceding this definition, the dictionary explicitly states that instinct was “formerly often regarded as a kind of intuitive knowledge.”

Kahneman himself sets the stage for the importance of getting words right in his discussion of the word “know” in his book, wherein he states on page 201:

“I have heard too many people who ‘knew well before it happened that the 2008 financial crisis was inevitable.’ . . . This is a misuse of an important concept.”

He then continues, stating that the words intuition and premonition, ironically enough, also are words that are misused (see page 202). In particular, Kahneman says that most people reserve both words “for past thoughts that turned out to be true . . . [but that] to think clearly about the future, we need to clean up the language that we use in labeling the beliefs we had in the past.”

Here is the Oxford English Dictionary definition of intuition:

  1. The action of looking upon or into; contemplation; inspection; a sight or view. (= Latin intuitus.) Obs.
  2. The action of mentally looking at; contemplation, consideration; perception, recognition; mental view.
  3. The action of mentally looking to or regarding as motive of action; ulterior view; regard, respect, reference. With intuition to (of), with reference to; in intuition to, in respect to, in view of, in consideration of. Obs.
  4. Scholastic Philos. The spiritual perception or immediate knowledge, ascribed to angelic and spiritual beings, with whom vision and knowledge are identical.
  5. (a) Mod. Philos. The immediate apprehension of an object by the mind without the intervention of any reasoning process; a particular act of such apprehension. (b) Immediate apprehension by the intellect alone; a particular act of such apprehension. (c) Immediate apprehension by sense; a particular act of such apprehension.
  6. In a more general sense: Direct or immediate insight; an instance of this.

Note the OED’s emphasis on such words as contemplation, inspection, consideration, perception, recognition, action, etc. Each of these words would, by Kahneman’s own definitions, make intuition more of a System 2 phenomenon. Additionally, the fifth definition is particularly noteworthy, with its emphasis on such phrases as “without the intervention of any reasoning process.” This would mean that intuition requires things like contemplation and inspection, but that it results in apprehension without any reasoning process. This means that intuition in its actual meaning is likely a mental process not covered by either System 1 or System 2 thinking.

It is interesting to note that in previous editions of the OED (e.g., The Compact Oxford English Dictionary New Edition, 1992), intuition was also described as

“direct perception of truth, fact, etc., independent of any reasoning process; immediate apprehension. . . . pure, untaught, noninferential knowledge.”

So, intuition is definitively not a gut-level, instinctual response but is instead a flash of insight and brilliance brought on by a conscious act of contemplation or inspection.

But it is not just dictionaries that view intuition differently than Kahneman does. In a 2013 presentation as the keynote speaker at Battle of the Quants NYC, Emanuel Derman, author of the books My Life as a Quant: Reflections on Physics and Finance and Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life andwhom many consider the grandfather of quantitative finance, pointed out that the foundations of science itself are the result of intuitive processes.

In his speech, Derman specifically pointed to Johannes Kepler, Sir Isaac Newton, André-Marie Ampère, James Clerk Maxwell, Albert Einstein, and Paul Adrien Maurice Dirac as scientists who experienced immediate apprehension and flashes of noninferential knowledge that advanced science in meaningful ways. These flashes of brilliance stand in stark contrast to Daniel Kahneman’s System 1 and System 2 thinking. Also note the venue in which Derman chose to make his points about intuition — a quantitative finance professional conference. To drive the point home to the financial community, Derman made similar arguments in the November/December 2013 Financial Analysts Journal.

In my book The Intuitive Investor, I describe intuition as “tuning into the cosmic radio station.” Using similar language, Derman says of intuition, “The observer becomes so close to the object (or person) observed that he begins to experience their existence from both outside and inside them. Intuition is a merging of the observer with the observed.” This is nearly identical in meaning to my use of the words “tuning in” for my definition of intuition. The operative word is “tuning” or, if you prefer,“harmonization” with the thing you are trying to apprehend. In both cases, intuition requires both process and deliberation, despite the ultimate “eureka moment.”

There are many consequences to the misuse of the word intuition, namely:

  • Such misuse confuses readers of Kahneman’s works as to what mental function he is describing. This confusion makes it difficult to follow his arguments because it is natural to map his descriptions to one’s own experiences. This confusion is also detrimental to Kahneman’s own work that is scientifically derived. At question is not his science but his nomenclature.
  • It destroys the sanctity of an important word. Intuition is one of only a few words that mean immediate apprehension and noninferential knowledge. So, misuse of the word intuition to mean instinct takes a powerful word out of our collective vocabulary, strips it of its meaning, and leaves people who have flashes of brilliance wanting for a word to use to describe their experience.
  • Once words are stripped of their meaning, it becomes difficult to describe their concepts, making them more difficult to conceptualize and nearly impossible to communicate about. In turn, this can lead to a minimization of or, in the worst case, disappearance of scientific inquiry altogether, because experiences lacking a description defy categorization and hence future exploration, experimentation, and quantification.
  • It denies the experience that nearly everyone has had of the sudden, truthful insight. If intuition is a bad thing, except in fight or flight situations, as Kahneman suggests, then people who have brilliant insights may rationalize away their actual “Eureka!” or “Aha!” moments as incorrect thinking. This is especially true given the gravity of Kahneman’s credentials.

To summarize: Words and their meanings are important. So, I ask that, going forward, intuition be divorced from Kahneman’s meaning of System 1 thinking. I also suggest that the word instinct replace intuition in his definition. In future columns in my series on intuitive investing, I will use the definition of intuition as set out in the OED and as supported by the experiences of scientists themselves through the centuries.

But why is any of this important to investment management? One of the conditions of intuitive insight is an unbiased, unattached mind — one free from preferences, prejudices, and the emotional constraints associated with the amygdala. It turns out that the ability to apprehend, comprehend, and resonate with the truth of the world as closely as possible is exactly the discounting process that every analyst is charged with fulfilling.

My assumption is that there is an objective reality greater than any one person’s ability to apprehend but that intuition, as a process and result of the mind, is the most powerful way to apprehend, comprehend, and resonate with the truth of the world. Science’s greatest discoveries, in fact, are the result of intuition. But without an understanding of the definition of intuition — or worse, confusion about its definition — analysts may leave a powerful analytical weapon on the alpha battlefield.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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