There is a significant difference between patience and indecision. When recommending or buying a stock, I will often wait patiently until the time and the price is just right. However, once the purchase decision is made, the execution is quick. Same holds for selling the stock.
For example, if a stock is within my buy range, I do not dither hoping that the price will fall another few points. Or when a stock hits my sell target price, it is sold without regard to the 100 posts being written in Seeking Alpha and Motley Fool claiming the stock being the greatest thing since sliced bread.
Over the years, I have been mostly right.
However, this post is not only about buying or selling a stock!
I spent this morning conversing with one of my valued members at Value Stock Guide premium. He reiterated something that I have heard from many other members over the last year. You can see his exact statement at the bottom of this post right here [opens in a new window/tab].
But there were further email exchanges between me and him.
Essentially the point that stood out for me was “people do not want to part with a dollar even if they make 2 in return”
Every one I know denies that this statement will ever apply to them. Still, study after study has shown that the psychological phenomenon called “loss aversion” is pretty much a universal human condition. I mentioned this as 1 of the 5 ways your brain is wired to force you into making bad decisions [opens in new window/tab].
Even when the benefits greatly outweigh the cost, you worry about cost. Given the choice between losing $1 in exchange of 75% probability of winning $2, you will chose to keep your dollar (curiously, playing a lottery exhibits a completely different phenomenon where the players willingly choose the option of a 99.99% loss of their dollar, but I digress).
Clarity of your decisions determine how much success you will have in investing
You do not have to be right on every stock. But you have to be decisive. This requires confidence that only comes from doing your homework. So take time to make up your mind but once you do, execute.
And if you are wrong, decide to exit and do it quickly.
The next step is to figure out where you went wrong, and use that as a learning experience so you do not make that mistake again.
But, if your decisions give more weight to right now (the $1 you lose) versus tomorrow (the $2 you gain), you will either refuse to make a decision or make the wrong one.
Fortunately, even in cases where you make a wrong decision, you can usually get back on course.
Iterative Learning: Why humans are better at investing then computers
Humans process information much faster and while self learning algorithms are in use today for trading, they still require a level of predictive inputs and instructions and often find themselves placed in situations not previously anticipated. The result could be a disaster (ala Knight Capital Group)
Last week at Starbucks I struck up a conversation with a certifiable genius who creates computational models for genomics. It is all very complex stuff and as he described the level of analytical rigor that goes into his work, he also expressed his fear of “a butterfly flapping its wings in China and setting off a series of events that grows into a raging hurricane in the Atlantic few months later”. His point: when we design genetic treatments to various diseases, it is usually important to understand that we may be causing an adverse effect months, years or decades down the line that we may not be able to tie back to the actual cause.
Something like this happens with all algorithmic models. Round off at the 10th decimal place instead of 12th, and your rocket might miss the moon landing. You might never know why, since all your models are correct.
Humans on the other hand are better at operating with fuzzy logic and can do mid way course corrections more efficiently. When we are catching a ball, our brain does not compute the speed of the incoming projectile, neither gives instructions to your hands to move at a certain angle. All it does is “a little bit left” “jump” stuff like that depending on the continuous feedback it receives from the eyes, and it does it efficiently because your body has a memory of doing this thing many times in the past (experience).
If you trust the management to do something, and they don’t, either there is a good reason for it that you understand, or there is not. You can review this information and decide what to do with your stock much better and faster than any computer can, or probably ever will. It is not merely intuition, you also have experiences you can call upon and a better understanding of motivations and impulses (sometimes called common sense).
It is important to step back from the financial ratios and models and make sure you understand yourself enough to invest properly. Common sense investing is hard and very few do it. I figured a weekend is a good time for reflection.
(I have friends who run high frequency trading models and also friends who create those models. I will probably get some flak from them for writing this, but as they say, why not)
- Is the Yale Model Past It? – Pragmatic Capitalism
- As S&P Hits Record, Investors Find Dirth of Value – Value Walk
- Buffett’s Career in Less Than 1000 Words – Aleph Blog
- Consensus Theory and Contrarian Investing – Arbor Investment Planner
- Still Due for a Pullback – Market Folly
- Are any of your Stocks Members of Triple Digit Club? – Bespoke Investment Group
- Visualizing 193 Years of Currency Regimes and Crises – Zero Hedge
- Robot Reality: Service Jobs Next to Go – Mish’s Global Economic Trend Analysis
- Due Diligence Disasters – Barry Ritholtz
- Economic Schedule for the Week of Mar 31 – Calculated Risk
And finally, to complement the topic of this post,
- How to Make Better Choices in Life and Work – Farnam Street
So what do you think? How do you handle your own decisions? How has that helped or hindered your investing?