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 “BUZZ WORDS” for 2013

In this global “LOW-GROWTH” macro-economic environment, I would use the following “BUZZ WORDS” to define World Central Bank and global market activity for 2013, as I see it at present.

*(I may update this list as the year progresses, as various scenarios become clearer, and as new events unfold.)

“MONEY PRINTING” and “EASY MONEY”

  • the Fed (and other Central Bankers around the world) provides low interest-rate loans to Banks
  • Banks are supposed to make this money available to companies and individuals at low rates that they deem appropriate (however, as demand for loans picks up, no doubt the Banks will raise interest rates, even though the Fed may not…a risk that will have to be factored into a company’s costs)
  • the Fed’s goal is to produce a “WEALTH EFFECT” (precisely who will benefit remains to be seen)
“INFLATE”
  • wholesale and retail prices of goods and services
  • price of stocks, commodities, etc.
  • taxes (more…)

Five Fatal Flaws

If you’ve been trading for a long time, you no doubt have felt that a monstrous, invisible hand sometimes reaches into your trading account and takes out money. It doesn’t seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, you just can’t seem to prevent that invisible hand from depleting your trading account funds.

Which brings us to the question: Why do traders lose? Or maybe we should ask, ‘How do you stop the Hand?’ Whether you are a seasoned professional or just thinking about opening your first trading account, the ability to stop the Hand is proportional to how well you understand and overcome the Five Fatal Flaws of trading. For each fatal flaw represents a finger on the invisible hand that wreaks havoc with your trading account.

The killer flaws? They are:

Fatal Flaw No. 1 – Lack of Methodology
Fatal Flaw No. 2 – Lack of Discipline
Fatal Flaw No. 3 – Unrealistic Expectations
Fatal Flaw No. 4 – Lack of Patience
Fatal Flaw No. 5 – Lack of Money Management

Aim Small, Miss Small

As many of you already know, one of the biggest factors in successful trading is how well you manage the trade – that is the stop-losses you place, the amount of capital that you put to work, where you take profits, and how you protect the profits that you already have. You could, no doubt, write many books on each of these subjects, but for now, I’m going to focus on a small, but critical aspect of risk-management and my inspiration comes from the movie “The Patriot”, which happens to be one of my favorite movies of all time.

In the clip below, Benjamin Martin (the father) asks his two young boys, “What Did I tell ya ‘fellas about shooting?” and they replied, “Aim Small, Miss Small”. Every time I hear those words I tell myself how true they ring across so many spectrums of life. As an avid hunter, if you just aim the gun at the direction of the game you are targeting, you are bound to miss. However, if you pick out a tiny, specific area of the animal, whether its the upper-right side of the chest, or some other smaller area, you have a much better chance of hitting your target. In fact, the smaller the target area, the lesser amount of margin for error you have in missing.

So how does this apply to trading, you must be asking? The stop-loss that we set in relation to our entry price is a reflection of our “Trading-Aim”

When I trade, I look for setups that are as close as possible to a desirable stop-loss. By desirable, that means I’m not just picking a spot that is 1 or 2% from my entry price for the sake of it being so, instead, if I am long, I am going to look to place a stop-loss somewhere underneath a critical support level, and if I am short, then I am going to place a stop just above an area of resistance. So the place that I choose for my stop-loss is that of a strategic area and a point to where I know, that if it hits the stop, I know that my thesis is no longer valid and therefore, I must exit the trade. (more…)

5 Mistakes Traders Make Again & Again

There is a big difference between bad traders and good traders, here is what I think separates one from the other:

  1. Bad traders continually have the desire to short the hottest  stocks with the strongest momentum. What is their reasoning? “It can’t go any higher, this price is ridiculous.” Do they understand it is a bull market, no. Do they understand the technicals or fundamentals that are driving this stock? No. Bad traders just trade their beliefs good traders trade proven methods.
  2. Bad traders continually believe they have found the trade “That just can’t lose.” It is a sure thing. No doubt about it. They trade BIG, they trade a HUGE position size. Unfortunately the most obvious trades are usually the losing trades, so they lose, and lose big. Good traders divide out their trades so that no one trade has too big of an impact on their account. Good traders realize EVERY trade can win or lose so they plan a quick exit for if they are wrong.
  3. Bad traders do not do the proper homework before they begin to trade. Really  Bad traders enter the markets with a mile of ego along with mud puddle deep understanding of what really works in trading. Bad traders have the belief that they are more clever than the markets and they can win based on their own intelligence. The problem is they do not do the homework of studying charts, trends, robust systems, winning methods, the right psychology for winning traders, risk/reward ratios, or the danger of the risk of ruin, or how the top performing stocks acted historically, and on and on. The good traders learn what it takes to succeed in trading, the complete story, while the bad traders learn some basics and think they are ready. They are wrong. The markets will show them.
  4. Bad traders make low probability trades, they are where the profits come from for the good traders. They go short in bull markets and long in bear markets. They sell naked puts on stocks collapsing into death spirals and sell calls on the best momentum stocks. They trade with big risks for small profits. They have a few small wins but some really huge losses. When they have a winner they take the profits quickly, but if they have a loser they let it run hoping that it will come back. They are the ones that lose the money, they are on the other side of the good traders trades.
  5. Bad traders want a good tip. They just want to be handed a winning system or a hot stock that just can’t lose. They do not even understand what all the talk of trading psychology and risk management is all about. They don’t need all that, they just want to make money. They just want the fish, they do not care about the fishing pole, bait, boat, or how to fish. Unfortunately they were to busy looking for that fish and didn’t understand the art of fishing, they will drown in the market ocean because they never learned how to swim themselves.

Russell Sands on What Causes the Market to Move.

Russell Sands was one of the original “turtles” trained by the famous commodity trader Richard Dennis. Dennis believed that commodity traders could be trained, as opposed to a colleague who believed great trading was an innate ablility. To settle a bet, Dennis placed ads in trade magazines and interviewed hundreds of candidates, eventually choosing 32 trainees. The new traders were named turtles, after the turtles Dennis saw being raised on a farm in Singapore.

   By the way, if that story line sounds familiar, you may have seen the movie Trading Places, starring Eddie Murphy and Dan Akroyd. And for my only movie review on this site, I give it two thumbs up. Very funny. (more…)

Winning Qualities of Successful Traders

Discipline is the key factor towards the success of trading/investing. Lack of discipline will result a bigger loses when you hesitate in cutting lost or when you enter a trade too early. Discipline no doubt is the bigger key deciding factor in any kind of field.

You need passion to drive you towards the success that you are hunger. You need the passion to do the boring job yet very rewardable at the end of the trading journey.

Tough time come you need to press it on. Never say quit attitude!!! Most of the Good Trader or Investor will experience a major downfall before they succeed in this business. If they did not fight back again then they will never succeed. Once again tell yourself press it on till you succeed.

Many people including me lack the virtue of patience. Trading and investing require plenty of patience as most of the time we are waiting at the sideline and let the newbies to kill each other. Once the market decide to go in the trend then we as a professional trader and investor will act upon it very fast. Being Patience alone will save you plenty and tons of money.

The more sweat you put in the greater reward you will get. Then again if you are doing the wrong thing every time again and again, this mostly likely tell you that your system of trading is not working and thus you need to change. There are a big different between hardworking and just stubbornly sticking to the failed plan. If the system of yours is CLearly not working after you put in months of efforts then you should just change your strategy.

Last but not least you need to strongly believe that you will be able to take money out of the market consistently. Believe that your Tested system will be able to last as long as the market condition do not change much.

7 Warning Signs for Traders

  1. You stop trading your plan and start “shooting from the hip” you are losing or winning so you believe that you are above your own rules, you start trading your opinions instead of your plan.

  2. You are about to take a trade you are 100% sure of, you have no doubt that it will work out. Trades that feel good to do and feel like can’t lose trades rarely win because everyone is already positioned in those trades.
  3. When you ignore your first stop and start deciding that you should give your trade “more room”, when you allow a loss to grow and rationalize why you should hold it instead of following your plan and stopping out you are in trouble.
  4. Averaging down in a position that is going against you is never a good idea, fighting trends are very dangerous amplifying your losses by increasing your position size can be fatal to your account.
  5. Fighting against the prevailing market trend over an over again can chop your account to pieces.
  6. When losing, you start trading bigger and bigger to get back to even. When you are losing you should start trading smaller and smaller to decrease losses.
  7. When you actually disagree with the market and believe it is wrong and you are right. Price is reality wherever it is, your job is to trade trend and price action not your own opinion.

Tactical Update From Bob Janjuah: "2008 Will Seem Like The Good Old Days"

Worth Reading :

Plse refer to my most recent comments, from 24th May, and 26th April. Things are playing out nicely. This is just a ‘tactical’ update. In my cmmt of the 24th May I set out 2 possible paths for the new bear market we are in, and I want to clarify a little:


 
1 – 1st, the bigger strategic theme is clear and unchanged  – global growth HAS peaked and the deflation trend is clear for the next 3/6mths. This is strategically bullish the USD and USTs (think 1 vs the EURO, and low 2% 10yr yields). And this is strategically BEARISH risk assets (think mid-800s S&P in 3/6mths, and the iTraxx XO index up above 750bps). The strategic asset allocation outlook STRONGLY favours QUALITY as defined by balance sheet strength, balance sheet transparency (which therefore excludes most financials), market position, AND the ability to be a price setter (not taker).
 
The game changers are: A) a massive turnaround in China towards new stimulus & a new credit creation binge etc – for now very unlikely IMHO; B) a massive  turnaround in corporate behaviour resulting in a leverage, capex, investment, hiring & spending binge – extremely unlike for now and for the rest of this yr; C) a new US fiscal package (pretty impossible now), so the most likely and only really viable remaining option is a MASSIVE DEBASEMENT/MONETISATION move led by the Fed (but no doubt globally co-coordinated) thru the announcement of a NEW (say) USD5trn QE package, aided/abetted by maybe another USD5trn of funny money printing by the BoE, the ECB, ther BoJ, the PBOC, the SNB etc etc………HOWEVER, I don’t expect this last bullet to be used until things get REAL UGLY (see above para for levels). If u know u have only 1 bullet left in the rifle – and unless you are amazingly stupid – u don’t try to shoot the charging grizzly bear when its 50 yards away. No, you wait till its 5/10yards away…WHEN we get this final bullet out of the rifle it had BETTER not miss, as if it ‘misses’ we would then have the mother of stagflationnary busts in history where bonds get crushed due to debasement, taking risk assets out with them too. If this is the outcome – and this is really I think a late 2010/2011 story – then trust me, 2008 really will seem like the Good Old Days…..lets hope Uncle Ben not only has the rifle ready, but also that his scope is well lined up and that he has been practising hard… (more…)

Two Trading related Films

Question. Have you seen the new Wall Street film, Money Never Sleeps? If so, what did you think?

http://www.wallstreetmoneyneversleeps.com/

The original film is, of course, a classic. I have no idea how many times I’ve seen it over the years, and no doubt will see it again several times in the future. I haven’t, as yet, seen the new one, but I fully expect to do so. 

It seems like the box office figures haven’t held up very well, but that’s not necessarily a reflection of the quality of the film where someone from a markets background is concerned. This doesn’t strike me as being one that requires the big screen experience, however, so I can see myself waiting for it to come out on DVD.

Should I not do that? I’d love to hear from folks who been. If so, leave a comment below with your thoughts.

A film I did see recently is Floored, the documentary about the decline of pit trading in the Chicago futures exchange arena. It was screened at the Vegas Futures & Forex expo, with the director in attendance. There were some interesting elements, but I’m not going to sing its praises from the rooftops or anything like that. Basically, it’s a tale of a disappearing business, which is part of they way things work in a free enterprise society. New, better ways replace older ones and folks who cannot adopt are left behind.

One of the most amazing scenes in Floored is one where a guy who clearly has embraced computer assisted trading is facing off against a floor trader. The latter is ranting about how computers are evil. It’s sad, really.

Go to top