rss

LOSING MONEY WITH METAPHORS

Freud’s psychiatric conclusions have largely been discredited but he rightly maintains praise for understanding the central role of metaphor and narrative in human thought. Professor Cowen HERE, is only the latest to build on this theme although importantly, he concentrates on the negative, blinding aspects of the tendency. Nowhere is this more clear than in the “stories” that surround investments.

Choosing a metaphor presupposes a conclusion. For instance, there’s no way to hear “the Chinese economy is a bubble” without unconsciously associating the country’s outlook with fragility and inevitable disappearance of a soap bubble. If we describe China’s GDP as similar to a hot air balloon on the other hand, our subconscious will immediately become more suceptible to the argument that upcoming government stimulus will right the economic ship. (You see what I did there – the use of the word “ship” is insidious.)

Good metaphors are a double-edged sword and their ubiquity in stock pitches suggests investors remain on their guard, never accepting one outright no matter how successfully it seems to communicates the situation.

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…)

Daily Trading Plan

Risk: your loss limit in per trade and the total dollar loss per day. What you will do after x number of losses in a row. Your strategy for increasing and decreasing your trading size.

Goals: how many R’s you are trying to make today. How many trades do you plan to make. How long do you plan to hold winners and losers 

Reporting: your plan for writing a brief narrative of the day’s trading your plan to keep statistics of your trades (hold times, results, et cetera). How you will mark your trades on the same charts you use to trade. 

Contingencies: what phone number do you call to get out of trades should your system crash. Who can you contact to troubleshoot or repair your computer. Who do you call to get your Internet connection checked and fixed, if needed.

 With a well developed, clear plan you will be ahead of the majority of traders and, through this detailed planning, you can concentrate on achieving your stated goals.

Daily Trading Plan

Risk: your loss limit in per trade and the total dollar loss per day. What you will do after x number of losses in a row. Your strategy for increasing and decreasing your trading size.

Goals: how many R’s you are trying to make today. How many trades do you plan to make. How long do you plan to hold winners and losers 

Reporting: your plan for writing a brief narrative of the day’s trading your plan to keep statistics of your trades (hold times, results, et cetera). How you will mark your trades on the same charts you use to trade. 

Contingencies: what phone number do you call to get out of trades should your system crash. Who can you contact to troubleshoot or repair your computer. Who do you call to get your Internet connection checked and fixed, if needed. 

With a well developed, clear plan you will be ahead of the majority of traders and, through this detailed planning, you can concentrate

Cold Truth About Emotional Investing

Consider an excerpt:

WSJ: What do you mean by emotional finance?

PROF. TUCKETT: What we try to do in emotional finance is start with the fact that the future is unknowable. The key thing about uncertainty is that it inevitably generates feelings. Because it matters to you, because your money’s on the line, so to speak, you’re bound to feel emotionally engaged.

WSJ: Some people think pros are more rational than individual investors.

PROF. TAFFLER: Although most of the fund managers we interviewed saw part of their particular competitive advantage as remaining, as they described it, unemotional or rational, in practice they were just as emotional as anyone else when they started to talk about the stocks they had invested in. There were lots of examples where they referred to them almost as if they were lovers.

If you’re entering into an emotional relationship with a stock, an asset or a company that can let you down, this leads to anxiety, which is often not consciously acknowledged. But it’s there, bubbling beneath the surface.

WSJ: The fund managers told stories about their investments. What was the role you found that storytelling played in their decision making? (more…)