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10 Most Common Behavioral Biases

I offer my list of Investors’ 10 Most Common Behavioral Biases.  There are a number of others, of course, and more will continue to be uncovered.  But I think that these are the key ones.  Your suggestions of important ones I have missed are welcome.

  1. Confirmation Bias. We like to think that we carefully gather and evaluate facts and data before coming to a conclusion.  But we don’t. Instead, we tend to suffer from confirmation bias and thus reach a conclusion first.  Only thereafter do we gather facts and see those facts in such a way as to support our pre-conceived conclusions.  When a conclusion fits with our desired narrative, so much the better, because narratives are crucial to how we make sense of reality.
  2. Optimism Bias.  This is a well-established bias in which someone’s subjective confidence in their judgments is reliably greater than their objective accuracy. Indeed, we live in an overconfident, Lake Wobegon world (“where all the women are strong, all the men are good-looking, and all the children are above average”).  We are only correct about 80% of the time when we are “99% sure.” Fully 94% of college professors believe they have above-average teaching skills (anyone who has gone to college will no doubt disagree with that). Since80% of drivers  say that their driving skills are above average, I guess none of them drive on the freeway when I do.  While 70% of high school students claim to have above-average leadership skills, only 2% say they are below average, no doubt taught by above average math teachers. In a truly terrifying survey result, 92% students said they were of good character and 79% said that their character was better than most people even though 27% of those same students admitted stealing from a store within the prior year and 60% said they had cheated on an exam. Venture capitalists are wildly overconfident in their estimations of how likely their potential ventures are either to succeed or fail. In a finding that pretty well sums things up, 85-90% of people think that the future will be more pleasant and less painful for them than for the average person.
  3. Loss Aversion. We are highly loss averse.  Empirical estimates find that losses are felt between two and two-and-a-half as strongly as gains.  Thus the disutility of losing $100 is at least twice the utility of gaining $100. Loss aversion favors inaction over action and the status quo over any alternatives. Therefore, when it comes time for us to act upon the facts and data we have gathered and the analysis we have undertaken about them, biases 2 and 3 – unjustified optimism and unreasonable risk aversion – conflict. As a consequence, we tend to make bold forecasts but timid choices.  (more…)

The Wisdom of Paul Tudor Jones

Here are some noteworthy quotes from the 80′s (yes 80′s) PBS special “Trader“, highlighting Paul Tudor Jones and his partner Peter Borish’s trading strategies. I’d like to thank Rodrigo for sending me this special, as I wasn’t familiar with Jone’s career. Even after a decade in the business you can still keep learning from successful traders in the hopes of fine tuning one’s craft.

What I found refreshing about Jones is his commitment to helping underprivileged high school students and his pledge to pay for their college education as long as they complete high school. And more importantly, the giving of his time each and every week to intervene in their lives.

“If life ever ceases to be an educational experience, I probably wouldn’t get out of bed.”

When the headlines are extremely negative day after day and the market refuses to go down, it’s “telling a different story than what the headlines are.” When the markets sell off in the morning and are bought up in the afternoon, it’s a sign of quite accumulation.

“After awhile size means nothing. It gets back to whether you’re making 100% rate of return on 10k or 100 million dollars. It doesn’t make any difference.”

“Trading requires an energy level, and it’s very difficult to sustain it 24 hrs a day, which is what this requires. To do the job right requires such an enormous amount of concentration that you’ve got to be able to…it’s physical and emotionally mandatory to find some time to relax, and you’ve got to be able to turn it off like that.”

“The whole world is simply nothing more than a flow chart for capital.” (more…)

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