Cognitive Dissonance Theory

The basic assumption of cognitive dissonance theory is that people are motivated to reduce inconsistent cognitions. Cognition refers to any kind of knowledge or opinion about oneself or the world. We see as bull and bear markets develop traders, investors and the general pubic change their opinions or hypotheses about themselves and their environment. This is the crux of the cognitive dissonance theory which is a general theoretical framework which explains how this comes about and is a patterned behavior. An important application of cognitive dissonance theory is research on attitude change.

Two cognitions can be either relevant or irrelevant.

If they are relevant, then they must be consonant or dissonant (i.e. that one does not follow from the other). Dissonant cognitions produce an aversive state which the individual will try to reduce by changing one or both of the cognitions. If, for example, a heavy smoker or drinker is exposed to statistics showing that smoking leads to lung cancer and drinking to brain and liver damage, he or she can change the cognition about how much he or she smokes ("I’m really only a light smoker") or drinks ("I’m really only a social drinker") or perceive the statistical data as hysterical environmentalist or fundamentalist propaganda and discount it.

Cognitive dissonance can be reduced by adding new cognitions, if (a) the new cognitions add weight to one side and thus, decreases the proportion of cognitive elements that are dissonant or (b) the new cognitions change the importance of the cognitive elements that are in dissonant relation with one another. The other way to reduce cognitive dissonance is to change existing cognitions. Changing existing cognitions reduces dissonance if (a) the new content makes them less contradictory to others or (b) their importance is reduced.

If new cognitions cannot be added or the existing ones changed, behaviors that have cognitive consequences favoring consonance will be recruited. Seeking new information is an example of such behavior. We apply this logic to mass market behavior and is certainly a way to explain and gauge impulse waves in market patterns, social and cultural revolution and whatever else mass psychology. Sit down and make a list on how you may have reacted with this behavior and how you think the market has — you will be surprised and you won’t be!