Human Behaviour as a Barrier To Trading Success

We’ve discussed the impact of emotions as recently as Friday.  Its fairly apparent that "Human
beings are simply not rational creatures. If they were, then no one
would have ever made money out of selling pet rocks. Yet someone did,
which only emphasises the long held belief that a fool and his money
are easily parted."

That’s a quote from Whitney Tilson in a recent article in the AustralAsian Investment Review. He obserrves that one of the biggest problems facing human investors is
that they tend to be overconfident in their view of things. Not just
"robustly", but "wildly" overconfident. He provides the following
statistical examples:

– 82% of people say they are in the top 30% of safe drivers;

– 86% of Harvard Business School students say they are better-looking than their classmates;

– 68% of lawyers in civil cases believe their side will prevail;

81% of new business owners think their business has at least a 70%
chance of success, but only 39% think any business like theirs would be
likely to succeed;

– Mutual fund managers, analysts, and business
executives at a conference were asked to write down how much money they
would have at retirement, and how much the average person in the room
would have. The average figures were $5 million and $2.6 million

In regards to the last example, apparently it doesn’t matter who the audience is, the ratio is always about 2:1.

Tilson has put together an excellent guide for the "Rational Investor." It is, as he notes, "hewn from years of good and bad experiences."

Here’s his rulebook:

– Don’t anchor on historical information, perceptions, or stock price;

– Keep an open mind;

– Update your initial estimate of intrinsic value;

– Erase historical prices from your mind; don’t fall into the "I missed it" trap;

– Think in terms of enterprise value, not stock price;

– Admit and learn from mistakes, but learn the right lessons and don’t obsess;

– Put your original investment thesis in writing so you can refer back to it;

– Sell your mistakes and move on; you don’t have to make it back the same way you lost it;

– Be careful of panicking and selling at the bottom;

– Don’t get fooled by randomness

The entire article is worth a read.

Incidentally, I have been reading Tilson’s sober analysis for years, and was pleased when I found out he was opening his own mutual fund. Whiole I do not knpow  his long term performance record, he has always impressed me as the sort of fund manager that Wall Street needs more of:  Contemplative, ethical, and investor-focused.


Human Behaviour: The Greatest Barrier To Trading Success
Australasian Investment Review (AIR), May 30 2005

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