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The Psychology Of Speculation – The Disconcerting Effect Of Sudden Losses And Gains
Time for another classic trading book excerpt. The subject is similar to the one in yesterday’s post. It is about limiting losses and ultimately becoming a better trader if you are willing to embark on that never ending journey to better understand yourself. James L. Fraser from Fraser Publishing clearly understood that. The introduction he wrote clearly shows his deep understanding of human psychology, trading and speculation. Human behavior never changes. That’s why I am a huge fan of old classics. Buy those books. Read them. Apply the wisdom imparted.
Henry Howard Harper: ‘The Psychology of Speculation – The Human Element in Stock Market Transactions’
Introduction
First privately printed by the author in 1926 and only found in secondhand stores at rare intervals this classic deserves a more wide spread audience. Harper’s human behavior material gives us insights into the handicapping prejudices that ruin our stock market theories and sound resolutions. Especially in our computer oriented age does the average investor seem incapable of calm reasoning , with the result that he often does precisely the opposite of what he had intended doing.
Moreover, Harper’s easy writing style clearly shows you how the correct ideas of theory are turned into the wrong formulas of practice, and how tickeritis, though mentally intoxicating, leads on to poverty. In a contrary way, we seldom see the favorite caprice of the stock market which is to violate precedent, and do the thing least expected of it. You had better believe it for there are no certainties in this investment world, and where you have no certainties, you should begin by understanding yourself. (more…)
Buffett unveils preliminary Berkshire Hathaway Q1 results
Soros, fallibility, reflexivity, and the importance of adapting
When I first read The Alchemy of Finance by George Soros, I thought his “theory of reflexivity” was absurd. It seemed to be an ex post facto explanation for his investment success. Now, having spent more time in the financial markets, I believe he was correct in his observations. We live in a world in which the markets do not stand still.
It is important to recognize that the idea of reflexivity does not stand on its own. As Soros states:
“The two principles [fallibility and reflexivity] are tied together like Siamese twins, but fallibility is the firstborn: without fallibility there would be no reflexivity.”
What does Soros mean by fallibility?
“My conceptual framework is built on two relatively simple propositions. The first is that in situations that have thinking participants, the participants’ views of the world never perfectly correspond to the actual state of affairs. People can gain knowledge of individual facts, but when it comes to formulating theories or forming an overall view, their perspective is bound to be either biased or inconsistent or both. That is the principle of fallibility.”
Soros lays out the argument that behavioral economists would be making for the next three decades: We humans are not perfectly rational decision makers. Instead, we are prone to all manner of information gathering and analytical biases.
Where things get interesting is when these biases have an effect on the markets. Not only will markets do some really strange things, like produce the dot-com bubble, but these beliefs change our behaviors forever. (more…)
You'll have to choose. "Good" strategy involves focus, thus requires choice. If not, the result is "bad" strategy.
Thoughts from Legendary Investors
On Waiting…..
Wait for the fat pitch. – Warren Buffett: comparing investing to a baseball game where you can wait endlessly for the perfect pitch before you swing.
I only go to work on the days that make sense to go to work…And I really do something on that day. But you go to work and you do something every day and you don’t realize when it’s a special day. – George Soros talking to Byron Wien
His first conclusion was that he won when all the factors were in his favor, when he was patient and waited for all the ducks to line up in a row. – from Jesse Livermore, Worlds Greatest Stock Trader
Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed. …Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.- Gerald Loeb
You make money on wall street by being very selective and being patient, waiting for those opportunities that are irresistible, where the percentages are very heavily in your favor.- Seth Glickenhaus
Unless, however, we see a very high probability of at least 10 percent pretax returns (which translate to 6 percent to 7 percent after corporate tax), we will sit on the sidelines. With short-term money returning less than 1 percent after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity.- Warren Buffett
Many equity investors feel compelled to remain 100% invested in equities at all times. Bond investors are often similarly constrained. We strongly believe that this mentality leads to pursuit of relative rather than absolute investment returns, a direction we certainly want to avoid…A smaller pool of funds seeking to avoid meaningful declines in market value at every point in time and seeking more aggressive return objectives cannot afford to be fully invested in the absence of attractive opportunities. – Seth Klarman
On Mistakes….
…if anything, I make as many mistakes as the next guy. But where I do think that I excel is in recognizing my mistakes, you see. And that is the secret to my success. The key insight that I have reached is recognition of the inherent fallibility of human thought. –George Soros
The only way you get a real education in the market is to invest cash, track your trade, and study your mistakes! – Jesse Livermore
On Psychology… (more…)
Courage and Trading
According to Plutarch, “Courage stands halfway between cowardice and rashness…” Clearly, we don’t want to be reckless; and clearly, we don’t want to be hesitant and timid. What we need is a balance. As we go about our trading moderating our greed and our fear to a combination of healthy desire and clear minded caution, we use courage to go forward.
Courage doesn’t mean closing your eyes, holding your nose, and jumping into the deep end. It does mean moving forward with clean and clear perception as well as steadfastness of purpose.
You don’t need courage if you’re totally confident and unafraid. Courage, according to John Wayne, is being scared to death and saddling up anyway. Because people tend to fear the unknown, and the unknown is all that is certain about any given trade, we need to employ courage. Since trading is always new, since anything can happen and it often does, since the wildness lies in wait, we need to overcome uncertainty and fear so that we can appropriately enter, exit, and remain in trades. (more…)
Successful Traders are Having 3 Things
1) Resilience – Successful traders take risk. Successful traders are sometimes wrong. Successful traders take hits. Successful traders learn from the hits, get up, and move on. They are resilient. They succeed, as Churchill observes, by moving from failure to failure with enthusiasm.
2) Selectivity – Successful traders have clear criteria for what makes good trade ideas. They also have separate criteria for what turns good ideas into good trades. They don’t watch everything, and they certainly don’t trade everything. They wait for good ideas to become good trades.
3) Calling – Successful traders have an uncanny sense that this is what they’re meant to be doing. It’s not a job, and it’s not a career for them. It’s a calling. That’s the only thing that can keep people searching and re-searching, banging away for good ideas and good trades. And it’s the only thing that enables them to gain the immersive pattern recognition experience that separates them from average traders.
To be sure, there are other success ingredients, from discipline to creativity. What I see among the traders listed above, as well as those I work with, is an unusual combination of these three factors. It’s a pleasure and a true education to study successful people. There is much more to success than avoiding failure.
MuhammadAli wins gold medal at the 1960 Rome Olympics
