by Curtis Faith:
Preconceptions Can Bias Decisions
When making a prediction of whether a stock price will increase or decrease, do you weigh all possible information equally or are you sometimes swayed by a company's image? Prudent decision-making requires the thorough consideration of all objective facts, but decision-making is often biased by our preexisting attitudes and images. Sometimes, we view certain sectors or commodities as "hot" or "up and coming," and we may base our predictions on these attitudes, rather than concrete facts and logic.
The recent dot.com bubble illustrates the disadvantage of using a company's image to make forecasts. Many investors forecasted extreme growth of stocks in this sector. Decisions were based on the image of dot-coms having extreme growth potential, rather than specific facts, such as the actual sales or earnings of the dot-com companies.
Dr. Donald MacGregor and colleagues at Decision Research recently conducted a study to illustrate how preconceptions and images of stock sectors can bias price forecasts.
A group of advanced business students enrolled in a securities analysis course was asked to make decisions regarding a set of industry groups on the New York Stock Exchange. Examples of the industry groups were computer software, pharmaceuticals, railroads, and managed care. Unknown to the participants, half of the industry groups consisted of high performing stocks (greater than 20% return) while the other half consisted of low performing stocks. Participants rated each industry group on whether they had a positive (for example, value, activity, and strength) versus negative image. They were also asked to predict the rate of return for each industry group.
Analysis indicated that industry groups rated more positively were predicted to have the highest return. However, a company's image had no relation to actual market performance, as measured by weighted average returns for the industry group. In other words, participants allowed their beliefs that a particular industry group had an "image" of strength, growth, and profit to bias their forecasts.
This study shows how attitudes, beliefs and preconceptions have a powerful influence on our decisions. People have a tendency to form strong opinions about which stocks or commodities will grow in value. Many times, these opinions are based on nothing more than an "image" or gut feeling.
Don't let your preconceived images bias your price forecasts. Be aware that, sometimes, you may have a positive image of a company that may override your logic. Try to minimize the influence of these attitudes. Double-check your facts. Reevaluate your indicators. Make sure that your decision to enter a trade is based on solid ground, rather than "images" or unfounded expectations.
Insights
Stress Management
"It is crucial to maintain a good attitude, so it is important to approach investing with positive thinking. Don't be glum. Avoid foolish thoughts. Learn from every experience. Do what you are supposed to do. No door closes that doesn't open another. If you have your health, you still have everything - without health, you have nothing. Tomorrow is another day. We live and learn. Life goes on - this is the way it is and therefore is supposed to be. Investing results are no reflection on your manhood, or your womanhood. We have ups and downs, and we will prevail. We have defeats yet are never defeated. There are no guarantees. If you don't have any other options, you don’t have a problem, so don't worry about what you can't affect; the challenge is to understand when there are no other options, and to stop chasing what does not work. When you hear bad news yet can't change it, don't worry about it; the world was made that way and it will remain so long after we’re gone. Let things be."
- James Dines, author: Mass Psychology
Self Awareness Insight
"If you have never had your limits tested, should a big loss occur, how will you know you can reach deeply enough into yourself to find a sense of identity that transcends your financial status? Or are you just a 30 percent loss away from feeling like a 'failure' and ending up in my psychotherapy consulting room?
"This is why I argue for knowing your own personality tendencies and seriously considering them in your online investment decision making. If you already know that the terrible anxiety of financial loss would be more than you can mentally and emotionally tolerate, this concern must be weighed heavily in the risks you take."
-The Disciplined Online Investor, by Steven Hendlin, Ph.D., p.47
Master Interview Highlight
Library, Curtis Faith excerpt
Question: Have you noticed anything special?
Answer: I think one of the interesting things I've noticed over the years as an outsider taking a look from an "every few years" perspective, is that there's this consistent sense of, "Oh, well. This doesn't work anymore." One of the greatest dangers that traders face is uncertainty about the approach they are taking, and whether or not it's going to continue working. I find, invariably, that just when people write something off is the exact wrong time to stop using it. (Laughs)
And I don't think that's coincidental. I think it is very much a part of the reason you get good markets and good trends, because a lot of people have given up. So you don't get the same sense of everybody jumping aboard price movement. I think it happens when everybody believes that something is going to happen. Then you get a whole mix of types of people who will enter a position in a particular direction.
Question: How does that play out in the real world of trading?
Answer: Let's say the whole world believes gold is going to go up. And there might be some basic, underlying, fundamental reason why gold should, in fact, go up. Whatever that reason may be, let's just say there's upward price pressure on gold, independent of the speculators. What happens is that the price starts to go up and a bunch of people get into it and they each have different tolerances and different expectations.
So a lot of people will be up thirty, forty percent on their account. They'll want to lock in some profits. So when prices start moving a little bit against you, you tend to get much more violent swings, up and down. While the price may, let's say in one circumstance, go from three hundred to four hundred, if you don't have a lot of people in the position, if you don't have a lot of people speculating, the price movement can be a lot smoother and you can make a lot more money. Basically you can buy it and get rid of it at four hundred and make a hundred bucks in the gold position. But if there are a lot of people who really believe that gold's going up, you'll tend to get much more spiky price movement, and it's harder to make any money. Even if it moves, it might go up to three twenty-five, then back to three-ten or back to three hundred and then up to three fifty then back to three twenty-two. It is a lot harder to make money in those sorts of markets.
What tends to happen, I think, is that a lot of people get demoralized and stop trading. They don't take a position because they're just convinced, "Gold has done this for the last six years. It's not going to go up. I'm really tired of getting beat up in gold, so I'm not going to take this gold trade." It's at those times, almost invariably, that you will get a very nice trend in gold, if there would be one. The setup of people being demoralized and assuming something can't happen makes it much more likely that you will make money by it actually happening.
A good example from the Turtle days was that we traded coffee for four years and lost money. I'm not sure who made the decision, but the last year I traded we were told that we weren't allowed to trade coffee. It was the first year we had a fantastic trend and I would have made probably a hundred fifty percent, two hundred percent on my account, just off coffee trades that year, based on exactly the same sizing that I had been trading the year previous. I don't think that was coincidental. I think there were an awful lot of people who had written off coffee as just too controlled by insiders or just not a good market to trade. |
