This post is a continuation of my earlier posts. I suggest reading The Art of Selling - Preview,
The Art of Selling - Winning the Loser's Game,
The Art of Selling - Who is on the Other Side?,
The Art of Selling - 10 Commandments, and
The Art of Selling - Coffee Can Portfolio, before you read this post.
After writing this part in this series of posts, I realised it is too long. Hence, I have split it into three parts. In the first part, I have written about the importance of psychology when we invest. And in the next two parts, I have highlighted two investing biases that aren’t written about that widely and aren’t that well known.
The Psychology of Investing.
Historically biases have worked for humanity, and they exist for very good evolutionary reasons. The problem is that they just don't work in the Stock Market. The reason that our biases are so harmful for us in the investing process is because the process of price discovery in the stock market is counter-intuitive. In the stock market, more than anywhere else, causation is not correlation. Things are not neatly ordered, randomness is a feature, not a bug. As a result, history doesn’t exactly repeat. Surprises are endemic. And, if anyone thinks that they can forecast outcomes, they are in for rude surprises. The unthinkable can happen and very often does. Valuation is another huge unknown and there isn’t any perfect manner of valuing a financial asset like a stock. There really is such a thing as a paradigm shift, when people’s opinions about the future, change dramatically and suddenly. We have seen all the above in the last 18 months.
I can riff separately about concepts like valuation, forecasting and whether history does indeed repeat. The underlying is what I am going to spend some time about instead. And the underlying is that human behaviour is the only constant. Human behaviour hasn’t changed in centuries and it will not change in the future either. In the stock market, price matters. The process of price discovery is almost totally determined by the collective behaviour or by the wisdom of the crowds. The vast majority of investors know of the fact that sentiment matters, but its importance is underestimated.
Because all the above is undeniably true, investing is less a field of finance and more a field of human behavior. The key to investing success is not how much we know, but how we behave. And our emotions affect the way we behave. In the stock market, our investing behavior matters more than any other abilities that we may possess. Hence, rule-based approaches (like the Coffee Can strategy) work.
What a ‘Coffee Can’ indirectly does is to protect ourselves from our emotions. But that is only if we can keep our emotions out of our investing process. And the reason that the Coffee Can approach hasn’t gained mass acceptance is the simple fact that most of us cannot control our emotions. We end up breaking the rules of the coffee can process.
If the stock selection part isn’t done diligently, then the Coffee Can approach wouldn't work, and even the best behaviour wouldn't help. Assuming that we overcome that hurdle, following the rules based approach of the Coffee Can strategy is what almost all of us find to be insurmountable. Our investing biases come in the way of our process.
The comic strip Pogo had a satirical slogan which said: ‘We have met the enemy and he is us’. The creator of the strip might as well have been talking about stock market investors. There aren’t any ‘they’, we come in our own way, it is our emotions that we have to overcome.
In the game of poker, the word tilt means that you're letting emotions - incidental ones that aren't integral to your decision process, affect your decision making. You are no longer thinking - you're experiencing an emotion that is not directly related to your decision. The same thing happens in the stock market.
There are two questions that need answering. The first one is: why do we exhibit investment biases? Without going too much into the weeds, it is basically because we can't separate our emotions from our investing decisions - the former influences the latter. As a result, we end up succumbing to our investing biases. The second question is: how do our emotions interfere with our rational mind? The problem is that pattern recognition and prediction are biological imperatives. Unless we attempt to fight these off when we are engaged in the investing process, these two are just automatic and, more often than not, they are pernicious.
There are scores of biases that humans suffer from. I will highlight a couple that aren’t that well known.
Click here to go back to The Art of Selling - Index
The Art of Selling - Winning the Loser's Game,
The Art of Selling - Who is on the Other Side?,
The Art of Selling - 10 Commandments, and
The Art of Selling - Coffee Can Portfolio, before you read this post.
After writing this part in this series of posts, I realised it is too long. Hence, I have split it into three parts. In the first part, I have written about the importance of psychology when we invest. And in the next two parts, I have highlighted two investing biases that aren’t written about that widely and aren’t that well known.
The Psychology of Investing.
Historically biases have worked for humanity, and they exist for very good evolutionary reasons. The problem is that they just don't work in the Stock Market. The reason that our biases are so harmful for us in the investing process is because the process of price discovery in the stock market is counter-intuitive. In the stock market, more than anywhere else, causation is not correlation. Things are not neatly ordered, randomness is a feature, not a bug. As a result, history doesn’t exactly repeat. Surprises are endemic. And, if anyone thinks that they can forecast outcomes, they are in for rude surprises. The unthinkable can happen and very often does. Valuation is another huge unknown and there isn’t any perfect manner of valuing a financial asset like a stock. There really is such a thing as a paradigm shift, when people’s opinions about the future, change dramatically and suddenly. We have seen all the above in the last 18 months.
I can riff separately about concepts like valuation, forecasting and whether history does indeed repeat. The underlying is what I am going to spend some time about instead. And the underlying is that human behaviour is the only constant. Human behaviour hasn’t changed in centuries and it will not change in the future either. In the stock market, price matters. The process of price discovery is almost totally determined by the collective behaviour or by the wisdom of the crowds. The vast majority of investors know of the fact that sentiment matters, but its importance is underestimated.
Because all the above is undeniably true, investing is less a field of finance and more a field of human behavior. The key to investing success is not how much we know, but how we behave. And our emotions affect the way we behave. In the stock market, our investing behavior matters more than any other abilities that we may possess. Hence, rule-based approaches (like the Coffee Can strategy) work.
What a ‘Coffee Can’ indirectly does is to protect ourselves from our emotions. But that is only if we can keep our emotions out of our investing process. And the reason that the Coffee Can approach hasn’t gained mass acceptance is the simple fact that most of us cannot control our emotions. We end up breaking the rules of the coffee can process.
If the stock selection part isn’t done diligently, then the Coffee Can approach wouldn't work, and even the best behaviour wouldn't help. Assuming that we overcome that hurdle, following the rules based approach of the Coffee Can strategy is what almost all of us find to be insurmountable. Our investing biases come in the way of our process.
The comic strip Pogo had a satirical slogan which said: ‘We have met the enemy and he is us’. The creator of the strip might as well have been talking about stock market investors. There aren’t any ‘they’, we come in our own way, it is our emotions that we have to overcome.
In the game of poker, the word tilt means that you're letting emotions - incidental ones that aren't integral to your decision process, affect your decision making. You are no longer thinking - you're experiencing an emotion that is not directly related to your decision. The same thing happens in the stock market.
There are two questions that need answering. The first one is: why do we exhibit investment biases? Without going too much into the weeds, it is basically because we can't separate our emotions from our investing decisions - the former influences the latter. As a result, we end up succumbing to our investing biases. The second question is: how do our emotions interfere with our rational mind? The problem is that pattern recognition and prediction are biological imperatives. Unless we attempt to fight these off when we are engaged in the investing process, these two are just automatic and, more often than not, they are pernicious.
There are scores of biases that humans suffer from. I will highlight a couple that aren’t that well known.
Click here to go back to The Art of Selling - Index
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