Tag Archives: mean reversion

LESS IS MORE – The Paradox of Choice

Posted on by under Behavioral Finance

When we go for any kind of shopping, we have lots of options available with us to select from. Nowadays, we are getting bombarded with options, such as hundreds of mental disorders, thousands of different careers, even more, holiday destinations and an infinite variety of lifestyles.

When we have offered with lot many options then our mind gets confused about what things we looking for and that will result in postponing of selection or we selected the wrong option. That will create dissatisfaction after selecting an option.

Investment – When we come to equity investment, we have almost 3000+ listed companies available. Now, when we track movements of stock prices then definitely few of them comes as a winner and a few come as a loser in particular day or weeks or months. In addition, we are bombarded with lots of information from various sources. So, when we get offered and focused on so many options our mind starts getting confused. Now, similarly, we have different avenues for investment. We have some criteria for the selection of investment but when we see large options, our mind gets confused and ended up with few choices which later on becomes a part of our regret.

So that what we can do? We can make a checklist regarding what can be our selection criteria for investing and have to follow it rigidly. If the investment option falls under our criteria, then should proceed with it otherwise give it a pass. It is very difficult to perform practically for many people and that is a reason for very few get succeed in the investment field. If we cannot able to avoid noises then this flow of overloaded information will make us paralyzed to make an appropriate choice.

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

I am grateful to Mr.Meihol Jhaveri (Founder of Gatisofttech) for development of Lucky Idiot website.

NEVER JUDGE A DECISION BY ITS OUTCOME – Outcome Bias

Posted on by under Behavioral Finance

As an experiment, We prepare different chits and write down different stocks name on those piece of paper. Then we give it to different monkeys to pick it for a week. Few come out as a winner and few as losers. We continue playing the same with winners only. Over some time, one monkey comes as a right in all the time. The media calls that monkey a successful monkey and call everyone to understand his success mantra.

This is an outcome bias; we tend to evaluate decisions based on the result rather than on the decision process. When a person has a good performance track record of stocks picking then we consider him as a good stock picker or an expert rather than knowing the process or it can be possible that past results can be due to pure luck. I met few fund managers who do not read books or annual reports thoroughly but they have survived for 10-12 years so people call them successful and an expert.

In conclusion: never judge a decision purely by its result, especially when randomness or ‘external factors’ play a role. A bad result does not automatically indicate a bad decision and vice versa. So rather than tearing your hair out about a wrong decision, or applauding yourself for one that may have only coincidentally led to success, remember why you chose? what you did?. When we start understanding the process behind success, then we can easily recognize success as a part of luck or efforts.

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

THE DUBIOUS EFFICACY OF DOCTORS, CONSULTANTS AND PSYCHOTHERAPISTS -Regression to Mean

Posted on by under Behavioral Finance

Everything in a world moves toward an extreme direction from average and come back to average. This is known as a regression to mean. Sometimes we get more happy or sad and as time passes, we start coming back to our normal feelings. We tend to be nice to other people when they please us and nasty when they do not, we are statistically punished for being nice and rewarded for being nasty.

Poor performance was typically followed by improvement and good performance by deterioration, without any help from either praise or punishment. Our performance has an average point, sometimes we perform very better than average and sometimes perform below average and sometimes reach back to mean performance. So that when performance is above or below average, then it has a higher probability to meet the average which is known as a regression to the mean.

Investment – The price of the companies sometimes go either extreme to fundamental points but as time passes stock prices start moving towards fundamental performance and at some point fundamental performance and stock prices marched. The stock price cannot be sustained at either extreme. We have seen various cyclical events, business cycle and many more are responsible for the regression to the mean. We have experienced that market always walk away from averages for a period but it comes near to mean by its self-correcting nature. So that when anything moves at the extreme side of the mean then we must have to be ready for self-correction of it. Value investing mainly focus on reversion to mean theory. It believes that if the stock price is well below its fundamental value then now or later it will catch up with its fundamental value.

We have seen that the best performance in equities has come after the worst performance and vice-versa. So that we should not focus on a smaller period of outcome to make any conclusion. Rather should focus on a decently long period to understand mean reversion. But when fundamental performance is improving then we should compare market price with improving fundamental performance rather should wait to fall in price as it has risen in past. Also, we need to study thoroughly about fundamental of any business, its prospects, challenges faced by the business. Rather believing that if the business has performed well in past then it will repeat it in future. It may or may not repeat the same performance but that we have to conclude from a detail study of business.

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