THERE are many techniques for stock-market investors that attempt to get you to think critically and not to let your biases cost you money. The idea is that we get influenced by our own thinking. Is that a dumb statement? Of course, it is. The only reason we have a mind is to think things out and form a conclusion.
The story is told of a young British officer of the colonial 1st Bengal Lancers. One evening at sunset he sees a beautiful woman, an Indian princess perhaps, bathing down the shoreline of the Ganges River. He observes the way the sunlight plays on her skin and hair, and outlines her body. With each step he takes as he walks toward her, he becomes convinced the universe has put him at this particular time and place to find his lifelong love that will fulfill all his dreams.
As he moves within feet of the water’s edge, the woman turns toward him, and he realizes that she is an old, wrinkled, toothless hag, suffering from some horrible skin disease.
Now you know exactly what some of my own stock-market trades have been like.
Stock-market investors are told to “trade what you see”; not what you think you see, not what you want to see, and certainly not what you hope you will eventually see. But doing that requires both discipline and a very small ego. I was recently told that I might consider myself as an “expert nonexpert,” perhaps from the teachings of the ancient Greek philosopher Socrates. Maybe that is true based on Socrates supposedly saying something, like “I know that I know nothing.”
What that phrase means is not that a person might have a lack of knowledge, but instead that he cannot know anything with absolute certainty. Yet, most investors too often take an attitude of being convinced of the correctness of their investing decision.
You have heard me say that “forecasting is for fools,” because the moment we make a prediction about a stock or the stock market, in general, we tend to do two things. We immediately defend our judgment in the face of any disagreement, and then we tend to hold to our forecast or decision in the face of changing conditions.
As economist John Kenneth Galbraith said, “In the choice between changing one’s mind and proving there’s no need to do so, most people get busy on the proof.” He also wrote: “The only function of economic forecasting is to make astrology look respectable.” But that is another story.
That is not to say, though, that we should not make predictions about the market. I publically said some time ago on Twitter that the coming low price of Philippine Long Distance Telephone Co. would be at the P2,130 area. It was. One other person I respect said the same thing. But both of us who were incredibly correct in our prediction are not experts. We took our analytical skills to reach that conclusion, and we’re right. The pretty girl we saw turned out to be a pretty girl, after all.
However, too many investors are unwilling to change their minds and end up marrying the old, toothless, diseased-ridden hag.
Painkilling medicines are a multi-billion-dollar business, and pharmaceutical companies are always trying to come up with new ones. In order to convince regulators of the efficiency of their new drugs, they must beat the “placebo effect,” where a controlled group of pain sufferers is given both the drug and a sugar pill. In 1996 the real drugs beat the placebo by an average of 27 percent. In 2013 the gap was only 9 percent, meaning people got almost as much pain relief from a candy pill as from a real drug.
What is interesting is the gap has only narrowed in the USA. In Europe, Africa and Asia, there was no significant change in placebo responses. Apparently, Americans really want to believe in a miracle pain-killing drug and, perhaps, ignore the fact that the pain is still there. Stock- market investors can be the same way. The price is not going down, it is only “correcting.”
The Dunning-Kruger effect is a bias where individuals suffer from the mistaken belief that their actual ability is much higher than is really true. Nowhere does the Dunning-Kruger effect manifests itself more often than in the stock market—and maybe in politicians.
The worst thing that can happen to new stock-market investors at the beginning of their trading experience is to lose a lot of money. The second worse thing is to make a lot of money. The same is true for old timers, too.
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E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter
@mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.