| Psychological Bias | Effect on Investment Behavior | Consequence |
| Overconfidence | Trade too much. Take too much risk and fail to diversify | Pay too much in commissions and taxes. Susceptible to big losses |
| Attachment | Become emotionally attached to a security and see it through rose-colored glasses | Susceptible to big losses |
| Endowment | Want to keep the securities received | Not achieving a match between your investment goals and your investments |
| Status Quo | Hold back on changing your portfolio | Failure to adjust asset allocation and begin contributing to retirement plan |
| Seeking Pride | Sell winners too soon | Lower return and higher taxes |
| Avoiding Regret | Hold losers too long | Lower return and higher taxes |
| House Money | Take too much risk after winning | Susceptible to big losses |
| Snake Bit | Take too little risk after losing | Lose chance for higher return in the long term |
| Get Even | Take too much risk trying to get break even | Susceptible to big losses |
| Social Validation | Feel that it must be good if others are investing in the security | Participate in price bubble which ultimately causes you to buy high and sell low |
| Mental Accounting | Fail to diversify | Not receiving the highest return possible for the level of risk taken |
| Cognitive Dissonance | Ignore information that conflicts with prior beliefs and decisions | Reduces your ability to evaluate and monitor your investment choices |
| Representativeness | Think things that seem similar must be alike. So a good company must be a good investment | Purchase overpriced stocks |
| Familiarity | Think companies that you know seem better and safer | Failure to diversify and put too much faith in the company in which you work |
Archives of “bias” tag
rss7 Psychological habits
1. Overconfidence and optimism
Most of us are way too confident about our ability to foresee the future, and overwhelmingly too optimistic in our forecasts.
This finding holds across all disciplines, for both professionals and non-professionals, with the exceptions of weather forecasters and horse handicappers.
Lesson: Learn not to trust your gut.
2. Hindsight
We consistently exaggerate our prior beliefs about events.
Market forecasters spend a lot of time telling us why the market behaved the way it did. They’re great at telling us we need an umbrella after it starts raining as well, but it doesn’t improve our returns. We’re all useless at remembering what we used to believe.
Lesson: Keep a diary, revisit your thinking constantly.
3. Loss aversion
We hurt more when we sell at a loss than we feel happy when we (more…)
More Research Confirms The Benefits Of Overconfidence
Overconfidence may cause people to invest too much in volatile stocks because such stocks have a greater diversity of beliefs, and so if people dismiss the objectively bad odds of beating the market, such people will be drawn to stocks where they are in the extremum, and highly volatile stocks have the most biased extremums. One might think these people are irrational, but in the big picture people with this bias actually have a huge advantage, why Danny Kahneman said it’s the bias he most wants his children to have.
Two economists at Washington State University looked at twitter accounts for sports prognosticators and found that confidence was much more important than accuracy in generating followers. Their sad conclusion: Pundits have a false sense of confidence because that’s what the public, seeking to avoid the stress of uncertainty, craves. In other words, to be popular (read: successful), you need to be unwarrantedly confident. This takes either an amoral cognitive dissonance or ignorance. (more…)
Trading Wisdom
Successful traders:
1) are very solid with what he called the “basics” (tape reading, execution, preparation for the trading day),
2) have discovered the trades that fit your personality and became excellent at those and
3) realize that successful trading is about pulling a small bucket of profit water out of the market well multiple times (in other words they are not greedy).
4) a passion for trading,
5) the willingness to admit you are wrong in your bias and to change your bias or terminate a losing trade and
6) to work really hard to become better each day.
7) an ability to recognize what trades truly work for you and to STICK with them and
8) calmness in the midst of market volatility.
Unglamorous as it may sound, it looks like the clear winner is hard work and learning the basics. Should this be that big of a surprise? Wasn’t it Thomas Edison who said ” genius is 1% inspiration and 99% perspiration”? But it is interesting to note that two of the three put a very high premium on recognizing your trading strengths and focusing on those types of trades primarily.
Intuition
I have this interesting article I found. This is something we normally discuss in the 3-day live class. Read this real quick and as soon as your done, sit back and realize what just happened.
I cdnuolt blveiee that I cluod aulaclty uesdnatnrd what I was rdgnieg!
THE PHAOMNNEAL PWEOR OF THE HMUAN MNID
Aoccdrnig to a rseearch at Cmabrigde Uinervtisy, it deosn’t mttaer
in what oredr the ltteers in a word are, the olny iprmoatnt tihng is
Tahtthe frist and lsat ltteer be in the rghit pclae. The rset can be a
taotl mses and you can still raed it wouthit a porbelm. This is
Bcuseae the huamn mnid deos not raed ervey lteter by istlef, but
The word as a wlohe.
Amzanig huh?
Now I’m tinkihng aobut all the tmie I wtsead in sochol
lrenanig how to slpel……
What were you just reading? Nothing. Those were not words, they were letters mixed together that spelled absolutely nothing. Somehow each of us were able to create something out of nothing!? (more…)
Gambler’s fallacy
For a fair coin, the answer sho uld be that both outcomes are equally lik ely.
If you Believed that the next flip is more likely to be tails because “tails is due to come up” this is whats is known as gambler’s fallacy, a great example of availability bias. i.e ” availability bias occurs when our estimates of probabilities are influenced by what is most “available” .
The purpose of the quiz is simple .
As traders assess new information, all observations must be appropriately weighted in prices or estimates of probabilities. If traders are unduly influenced by availability bias, the resulting estimates may not be accurate. You must at all time in your approach be equally fair, balanced objective and dispassionate while gathering your analysis toward trading .
Trading Wisdom
If we want to be successful as traders it is crucial that we have great filters. We must filter out all the noise that separates us from the actual price action. In the end it is just us versus the market. We need to seek to learn how to trade from others and not look for trades. We have to play a lone hand because we have our own tolerance for pain, our own goals, and we should have our own trading plan with a robust methodology. Others do not know our time frame and we do not know theirs. Their position sizing may be ten times what ours is.
Before we trade we should have a watch list, a risk percent per trade, a methodology, and a trading plan. We should be running our trading like a business not a casino. Information and opinions can bias our trading. Be very careful about the information that you let into your mind. You should attempt to trade as close to your system and methodology as possible without allowing anyone’s opinions our thoughts to come between you and the charts. Actual price action is the king everyone’s opinions are just that, opinions. (more…)
Market Thesis
Purely academic, non applicable information. Writing them out helps me organize these assumptions into ideas. Hopefully you find some use for them.1) Trading is like any other business, but not only in the conventional sense. The market is manipulated. The underlining principle behind this statement is that equities market is the same as any other market in the economy, whether it be technology or tube sock market – those with the biggest market cap control movement and direction.
2)While prices are moving in a current path identified by trend lines, heads of market are processing information and making preparations for the next shift. During the time traders see the trend forming and change their “bias” in accordance with the trend, heads of market have processed new information and are ready to take prices to a new level.
3)Technical analysis is a visual interpretation of how crowds behave in relation to price. It does not influence how prices will or should behave. When prices reach a certain level, the technical indicator at that level does not dictate how prices will react, rather, (more…)
Embrace Uncertainty!
Willingness to Experience Uncertainty enables traders to follow adaptive (trend-following) strategies.
Unwillingness to experience uncertainty
provides a bias toward predictive (fundamental) strategies.
A Look at 9 Quotes from George Soros
1. Perceptions affect prices and prices affect perceptions
I believe that market prices are always wrong in the sense that they present a biased view of the future. But distortion works in both directions: not only do market participants operate with a bias, but their bias can also influence the course of events.
For instance, the stock market is generally believed to anticipate recessions, it would be more correct to say that it can help to precipitate them. Thus I replace the assertion that markets are always right with two others: I) Markets are always biased in one direction or another; II) Markets can influence the events that they anticipate.
As long as the bias is self-reinforcing, expectations rise even faster than stock prices.
Nowhere is the role of expectations more clearly visible than in financial markets. Buy and sell decisions are based on expectations about future prices, and future prices, in turn are contingent on present buy and sell decisions.
2. On Reflexivity
Fundamental analysis seeks to establish how underlying values are reflected in stock prices, whereas the theory of reflexivity shows how stock prices can influence underlying values. One provides a static picture, the other a dynamic one.
Sometimes prices change before fundamentals change. Sometimes fundamentals change before prices change. Price is what pays and until expectations change, prices don’t change. What causes expectations to change? – it could be change in fundamentals or change in prices. So what I am saying is that sometimes prices could be manipulated to change expectations, which will fuel further price momentum in a self-reinforcing way. (more…)