Category Archives: Behavioral Finance

We all know that temperament is one of the most important quality not only in the investment field but also in our life. If we work on our emotional biases then we can win any battle. To excel in temperament, first, we need to be aware of the various biases. So now onwards, I will illustrate various biases and how we can excel it and use it in our life. This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly”.

WHY WATCHING AND WAITING IS TORTURE Action Bias

Posted on by under Behavioral Finance

This is the action bias: look active, even if it achieves nothing. There are many situations where we do not know what will happen but we just act to show our active behavior in eyes of others.

When penalty kick in football kicked to goal. The goalkeeper just has 0.30 seconds to think where the ball will fall right, left, or center. It is difficult to guess in much less time so they jump either side which creates an illusion of doing something to stop the goal.

Investment – Similarly, when a fund manager knows that he cannot beat the market, then many fund manager keeps on churning stocks in a portfolio or they keep on buying one and other stocks which creates an illusion among their clients of doing something to beat the market and create wealth. Also, I have seen many fund manager who keeps many books with them so that when clients meet them, they can just create an illusion of avid reader.

‘All of humanity’s problems stem from man’s inability to sit quietly in a room alone,’. We need to learn the skill of patience because we cannot produce a child in a month by doing sex with nine women or with the same woman nine times a month. When the situation is not suitable with our philosophy and process then we have to keep patience to wait for the loose ball to hit a home run. We do not need to hit a home run on every ball and if we try to do that then remember, we cannot survive till a loose ball comes for a homerun.

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

THE DECEPTION OF SPECIFIC CASES Conjunction Fallacy

Posted on by under Behavioral Finance

Kahneman believes that two types of thinking exist. The first kind is intuitive, automatic, and direct. The second is conscious, rational, slow, laborious, and logical. Unfortunately, intuitive thinking concludes long before the conscious mind does.

Conjunction Fallacy means – the false belief that a conjunction of two events is more probable than one of the events on its own. – fs.blog

When we have a more detailed situation or more options available then we think that occurrence of it is higher. Compared with a situation that does not have details available.  

Investment – When we have a problem then our intuitive brain run for a solution without knowing the problem well but the conscious brain thinks all aspects and makes decisions. As we have seen about system 1 and system 2 if we rely only on system 1 for making an investment decision then it has a higher probability to meet a loss or have to get huge support from luck. When we received any tips or stories about stock from family or relatives then we tend to believe it without thinking further.

Conjunction fallacies continued to occur dominantly when the observed pattern of frequencies resembled conjunction. We should always focus on statistical evidence which helps us to make a rational decision.

FALSE PROPHETS Forecast Illusion

Posted on by under Behavioral Finance

We get many predictions from around the globe daily. Many come true, many fall nearer, and many fail. ‘There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know

If these predictors are proven right then they get publicity but if they fail then there is no penalty to them. So, it’s a win-win approach for them. Thus, they are bombarded with lots of predictions.

Investment – We get many tips on a routine basis from the different analysts/agencies. If there does not have any penalties for failure then people keep on sending as many as possible predictions or tips. Any tips will hit the target and they become famous. As everyone remembers success, not failure. If their increments, incentives are based on how many times they achieve success so that they are remains in control.

But we do not know every time that is their tips providers have something to lose or not? So that we should not trust every coming prediction blindly. We need to study all the predictions with our knowledge and process before accepting them.

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

CONGRATULATIONS! YOU’VE WON RUSSIAN ROULETTE Alternative Paths

Posted on by under Behavioral Finance

Alternative paths are all the outcomes that could have happened but did not. When we reach somewhere with one path but there are different paths or possibilities which is invisible and that can happen. But did not happen. If any alternative paths have happened then it has a possibility that we might not reach a destination or ruin in a way or reach faster or reach slower.

There can be several permutations and combinations for the occurrence of any events. If one event out of those numbers of combinations happens then it does not mean that another event cannot happen.

Let’s try to explain the concept with an example of the “What If…?” series of Marvel Cinematic Universe (MCU). We all know that how Mr. Tony Stark has become the Iron man in an MCU movie after he was kidnapped.

Its “What If” series has shown that, if Tony Stark was not kidnapped then he might not come out as Iron Man. We cannot be denied the occurrence of alternative events.

So does not the occurrence of one event has changed the entire story of Iron Man. Similar way, our life also has many alternatives to happen.

Investment – When we have gained through investment, we need to understand that there can be many alternative ways that have not happened. And that does not mean that we have not taken the risk.

Risk is not directly visible. Therefore, always consider what the alternative paths are. The success that comes about through risky dealings is, to a rational mind, of less worth than success achieved the ‘boring’ way. People only think about success but there can be different possibilities that need to focus on.

I know a few of my friends who bet on the company where the occurrence of some event can help the company to earn revenue (earlier no revenue). But what if the event does not happen? We must have to be ready for the occurrence of an unexpected event. Do we have any substantial margin of safety when the assumed event does not occur? Do we have at least winter soldier (chance to not lose much) if Tony does not come out as Iron Man?

When we make any assumption about investment, we also should prepare alternative events which can happen. There should be a scenario analysis while making any investment decision. (What If Tony Stark do not become Iron Man ?)

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.