Today I am going to try and show you how these four biases which I have written about early impact each stage of decision making in investing.
- Confirmation Bias :The tendency to ignore information contradictory to prior beliefs or look for information confirming prior beliefs.
- Herding : Also known as the “bandwagon effect,” herding is the tendency for individuals to mimic the actions of a larger group.
- Anchoring Bias :The tendency to rely too heavily on the first piece of information received.
- Disposition Effect: Investors tend to sell winners too early and hold on to losers too long.
The starting point for a retail investors starts off with a belief about which he/she has already made up his/her mind. And then they look for information to confirm that belief. They think they can understand or analyse the impact of demonetisation on the indian economy, Or the benefits of GST implementation or how inflation will impact the RBI's decision in the next credit policy and so on.
And they have the friendly business channels also to their rescue. If you close your eyes and try and listen for about 5 mins to what the anchors are saying something about the day's market movement, it will not amount to anything. That's 5 mins of your life you will never get back. (I have tried it).
Investors also believe they will correctly able to assess the impact of all this on the earnings of a company, on the sector and then are able to also express this into a position i.e. buy or sell or hold. Most of the time its a buy. And once they get some information that supports their prior belief, they get heavily anchored to that. And even if by chance they get information to the contrary they will find it hard to disregard the earlier information.
Now it is virtually impossible to get someone to consistently do all of the above. Not even Rakesh Jhunjhunwala or Warren Buffett will get all the time. Infact Steve Cohen has famously said that his best traders are right on a trade only 50% of the time. So now where does that leave the average retail person.
But with a high degree of confidence and ego invested, if the stock starts going south then disposition effect (tendency to hold on to losers) kicks in. One will tend to hold on to it even if the orignal investment belief is proven wrong and information is available to that effect.
And if by chance, the stock goes up, then itchiness to sell the stock and book profit kicks in. Greed and ego wants to lock in the gains.
However there is one place where one can get away with all this. Read the next two paras from an article by Barry Ritholz.
"In politics, you can get away with this. Voters live in
bubbles of their own making -- the selective perception and confirmation bias
through which they view the world. The penalty for fabricating your own
reality, false though it might be, seems to be minimal or nonexistent in
politics. Voters live with the consequences of the ballots they cast, though
the effects may not be felt for years. Making up alternative facts about
childhood vaccines, the unemployment rate, climate change or where your
predecessor was born certainly hasn’t hurt Trump -- it may even have helped him
win the election.
Investors, however, aren't quite so lucky when their belief
systems diverge from reality. Mr. Market seems to take delight in taking money
away from those whose capital is deployed based on a set of faulty convictions.
This is why I harp on cognitive issues, the importance of understanding your
own psychology and, most recently, not mixing politics with investing."
You can read the entire article here.
There are many other biases but these four are key. And today I will end here and from tomorrow we will move on to other aspects of investing like the nature of markets and how it is complex adaptive system which is never in equilibrium and then how trends are formed.
Thank you too all of you for reading and supporting. You all know who you are. I really appreciate the support and encouragement.
Regards
Anish
No comments:
Post a Comment