3 Psychological Investing Mistakes

13th Feb '19 by Jack Corsellis

11 comments 1724 reads

These are 3 of the most common psychological investment errors (in my view) and how we can find solutions as investors to these with the aim of increasing returns and not being our own worst enemy - I don't need anymore holes in my foot!

1. Anchoring bias

Anchoring bias is when an investor relies too heavily on an initial piece of information they receive / find. For example, you're driving home from work and drive past your local dealership to see the car of your dreams for £50,000. The dealership closed 30 minutes ago so there is no sales manger to talk to. You decide to pull over and have a quick look around your dream car. You're completely sold, but you know the wife wouldn't be impressed as you're suppose to be paying for 2 holidays this year, renovating the house, and not to mention your kids University fees. The next day you finish work earlier and are driving past the dealership which is open for business. You notice your dream car is discounted by 20% to ONLY £40,000. Wow, what a bargain! I must go in and buy it as it's on offer. I can explain to the wife why we aren't going on holiday or renovating the house because the car was 20% off so how could I not have bought it! Right?

This anchoring bias relates directly to stocks and their share prices. How often have you heard it was £10 a share, now it's only £5. This is the anchoring bias directly in action. You're assuming that because the initial information of hearing it was £10 a share and now it's ONLY £5 a share it must be a bargain. This is a difficult cognitive bias to overcome as we're constantly suckered into purchasing things we never really wanted just because we put significant weight on the initial price we saw. How often do we go shopping just to 'browse' but come back having spent £100's. What's usually the justification for spending the £100's? Well, it was on offer of course! How could I not at these prices!

Hopefully you're beginning to see the flawed logic to this approach and how it could be destructive to stock market returns. If the rationale for purchasing a stock was because it was discounted (you consider it 'cheap') then if the price keeps…

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Jack Corsellis

13th Feb '19

The GE chart didn't work, if anyone can enlighten me how to do it I'd be grateful.

HumourMe

png works:

coniston

They are excellent rules JC,have suffered all them in my earlier years& still have to a lesser degree with the first two..It's " the contrarian in me", another very important rule would be to cut your losers in small caps quickly if they're underperforming the market after a couple of months, sell & then re evaluate,a lot of small.caps never recover.

William K

Thanks jcorsellis. Very few of us are completely rational investors. I've made all of those mistakes but I now make them less frequently. The best book I ever read on psychological mistakes was by Daniel Kahneman 'Thinking, fast and slow' - it's not specifically about investing but it certainly helps you to distinguish between rational and irrational decision making.

mmarkkj777

14th Feb '19

Hi Jack,

Yes a really good piece. I think most investors could honestly say they have fallen into these traps at one time or other. Working to understand your own damaging traits and adopting a rules based system and having the discipline to follow it, goes a very long well to becoming a better investor/trader.

Recording everything helps too ( including rationale at the time). You can then go back and have a look at what didn’t work and tweak what you do in an effort to keep refining and improving.

Cheers, Mark.

Hi Mark,

When you say record things are you meaning your decision process and why you made such decisions at a specific time, or recording your trade results in an excel spreadsheet?

Best,
Jack

Hi Jack,

I mean the former.

I record all my transactions from a numbers perspective anyway (in a spreadsheet), but more recently (last couple of years) I have started to populate a record (in a normal paper desk diary), with just my thoughts and rationale as to why I bought/sold/added/reduced (just a few scribbled notes on the date page when I did it). Then if something goes particularly well/badly, I can go back and refresh my mind as too why I made the choice at the time. It then makes it a closed loop Think/act/review/improve cycle. It then works just like any other process improvement process. If you don't know why (or have forgotten) why you did something in the first place, you can't review it and improve continuously.
Seems to work for me. I guess some people would want to record it electronically, I'm a bit old school and prefer to scribble notes with a pen, but its the brief contents that matter. The reason I don't only use a comments column in the spreadsheet, is because I don't make the spreadheet entry often until a short while after the transaction (maybe even the next day if I'm busy) but the diary entry is instant, and can also work for potential trades that you choose not to complete on too.

AnonymousUser252054

Like with your discounted car example I find I can only bring myself to buy clothes or shoes etc if they are hugely discounted. But, let's go a bit further than a too simplistic notion of 'anchoring' bias. As we all know there's price and then there's the question of value and they are very different things. If I see a shirt for£10 reduced from £30 I would still ask myself if it's actually worth a tenner. Often heavily reduced clothing is not worth having if they were giving it away.

Hi Mark,

That's interesting as I do something similar, although all electronic (must be an age thing!!). You might enjoy a book called 'Thinking in Bets' by Annie Duke - she's a pro poker player. Obviously a lot of similarities between poker and investing, especially on the probabilities side.

She says in the book about the quality of your decision making process shouldn't be determined on the outcome of your result(s). For example, in poker, if you had an 83% chance of winning the hand and lost that doesn't mean it was the wrong decision and your logic was not flawed. If however you had a 10% chance of winning the hand and won it was more down to luck than good judgement (decision making process). In the latter example that can create numerous other psychological tenancies which could lead to future bad investment decisions - i.e., if you keep betting all your chips with only a 10% chance of winning you're going to blow up very soon. You might do this, and continue to do this, because you got lucky once.

By tracking results like Mark Minervini suggest it lets you know the odds and probabilities of your trading strategy so you can invest accordingly. I thought this was brilliant advice. Obviously your trading strategy needs to have a statistical winning edge otherwise you'll lose over time. The only way to know is to track actually results rather than what investors think hypothetically they'll make.

If you want to check out the book here's a link, I think it's well worth a read - Thinking in Bets Book

Best,

Jack

Shine66, you understand this better than most investors. But I've seen a lot who rationalise buying a share because it was £5 and now it's £4. With that logic an investor would keep buying it all the way to 1p. I agree there is a difference between buying value at a discount and buying rubbish at a discount. To determine which is which is a very difficult skill. Even the great Warren Buffett was down 40% between 1998 and 2008 (not many talk about that). If he'd had been a hedge fund he'd no longer be a hedge fund.

P.S I'm a big Buffett fan.

Best,
Jack

WarrantStar

Great post Mark!
I have a rigorous process that I must follow in a spreadsheet which I use to decide whether to buy or not. I have spent a lot of time improving this process over the last few years. Some of this is based on financial ratios, and some of it is based on more difficult judgements such as on competitive advantages. I keep a record of all these old analyses so that I can go back to them. Your post has prompted me to consider how I can make even better use of the Think / Act / Review / Improve cycle. Thanks.

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Jack Corsellis

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