Tag Archives: thinking fast and slow

WHY YOU SEE SHAPES IN THE CLOUDS – Clustering Illusion

Posted on by under Behavioral Finance

Many a time, people see the face of lord or shape of the lord, shape of a heart and so on in clouds. We hear many strange voices sometimes and feel that it wants to talk to us. The human brain seeks patterns and rules. It takes one step further: if it finds no familiar patterns, it simply invents some.

In the above images, we can see different faces in clouds. But actually, there is not any real face, our imagination creates faces in it.

Investment – In the market, we are getting overloaded with lots of data and many of us try to make patterns among those data. They use such pattern for trading into stocks. But that not work forever because we have created patterns where it has no existence.

When it comes to pattern recognition, we are oversensitive. We need to regain our scepticism. If you think you have discovered a pattern, first consider it a pure chance. If it seems too good to be true, find data which is tested mathematically and statistically. Never believe in any pattern if it is not supported with enough data over a long time.

Many investors believe that the company which choose buyback as a capital allocation plan then consider that company as a good capital allocator. But do we check rather a buyback is done below its intrinsic value or above its intrinsic value? What is the intension of the company behind buyback? Does the company want to hide previously diluted equity capital through buyback? So, we need to be sceptical before considering something as it similar as we saw it.

SIMPLE IS BETTER – ISSUE -13 – BUYBACK

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

DOES HARVARD MAKE YOU SMARTER? Swimmer’s Body Illusion

Posted on by under Behavioral Finance

For becoming good swimmers, we require a good body to develop. This is not a fact but it’s a result of good swimming. Female models advertise cosmetics and thus, many female consumers believe that these products make them beautiful. But it is not the cosmetics that make these women model-like.

Whenever we confuse selection factors with results, we fall under swimmers body illusions. When it’s talking about top graduate schools then Harvard, Oxford, MIT, IIM comes on top and it is considered that pass out from those colleges will give huge success in professional life but is it true always? It may be possible that they give admission to already bright students so they do well and get a good professional life.

Investment – Mr Buffett has made wealth through moat investment so we all chase his style without knowing that it will suit us or not, without knowing that Mr Buffett also owns world’s largest insurance company which generates good float for him to invest. 

So, when we stuck under such situations, we should write down what confusing us then invert that problem. In investment, people believe that high dividend-paying companies are good. But we should understand that the company is good because it can able to generate cash which is excess after investing in all business requirements so that the company can able to pay a higher dividend. Whenever any outcome or information we received, we need to always ask a question on how that outcome has resulted. We need to understand why some companies are successful and why some not rather using any thumb rules.

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

WHY YOU SHOULD VISIT CEMETERIES – Survivorship Bias

Posted on by under Behavioral Finance

In life, we focus more on winning, surviving rather than failure. This illusion kills our ability to calculate the probability of surviving, success. We cannot see that probability of success can be very small. We always taught about success and not taught about failure. This is known as a survivorship bias.

Many authors write a book but a few will achieve success. Thomas Edison failed many times before inventing of the bulb but today, we only remember with their success, survivor.

“I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times I’ve been trusted to take the game-winning shot … and missed. I’ve failed over and over and over again in my life. That is why I succeed.” ~ Michael Jordan

Investment – Similarly, very few have achieved success in the investment world but we overestimate the probability of success and ignore to look that many have spoiled their life. We focus on successful companies which have created a lot of wealth. When we visit any seminar or marketing people or media, they only talk about the successful companies which have created wealth but never talk about companies which have eroded wealth. Wealth creators are very few compared to wealth eroded. But we ignore the probability of losing and never try to learn from others mistakes. We all come to the stock market for becoming a next Mr Buffett but does not focus on developing ability and insights as similar to Mr Buffett & Mr Munger.

There are ~7000+ companies got listed on Indian bourse from that ~4294 companies are down almost 80%+ (many companies got unlisted or close) whereas we know that few companies which have generated wealth over a period. So ~60% of wealth destroyers are there compared to hardly ~3% wealth creators (maximum- if we see actual wealth creators for long term then that is ~1% only).

We can see that there are huge wealth destroyers companies available compared to few wealth creators. So that while investing don’t try to catch every opportunity available but prepare investment philosophy suitable to us, swing bat only when the suitable opportunity arrives. We need to prepare investment philosophy, process, circle of competence and investment style so that we can swing bat when things fall under our zone.

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

05 – Illusion

Posted on by under Behavioral Finance

Illusions of Remembering

The illusion is not only of visual but it’s also of memory.

If we have seen any words or something for even a millisecond then also when we see it again we feel it familiar. Something which is in contrast to others that also give us a feeling of familiars. This creates a memory illusion.

Illusions of Truth

When things seem familiar, we generally tend to accept it as truth. But when things seem unfamiliar or extreme then we tend to reject it.

The impression of familiarity is produced by System 1, and System 2 relies on that impression for a true/false judgment.

When we wanted something to accept by people as truth then we keep on repeating the same. Because familiar things are easy to accept as truth.

When we listen frequently that equity investment or real estate investment can help us to create wealth then we become familiar to it and we start believing it as a truth. When we see people surrounding us making money through trading then we also believe it as a truth. We also start doing it without thinking about it as a truth or not. It keeps getting repeatedly visible in front of us and we believe it as a truth.

How to Write a Persuasive Message

When we write something truth but it is not necessary that people also believe it as a truth. For that, we need to use a true illusion. We need to draft our writing in a good manner, with proper colour combination and do not make it very complex, make it memorable.

Strain and Effort

The performance was better with the bad font. Cognitive strain, whatever its source, mobilizes System 2, which is more likely to reject the intuitive answer suggested by System 1.

The Pleasure of Cognitive Ease

Companies with pronounceable names correctly better than others for the first week after the stock is issued, though the effect disappears over time. Stocks with pronounceable trading symbols (like KAR or LUNMOO) outperform those with tongue-twisting tickers like PXG or RDO —and they appear to retain a small advantage over some time.

Ease, Mood, and Intuition

Our mood has an impact on system 1 and intuition. When we are uncomfortable, suspicious and unhappy, we lose touch with our intuition. And our system 2 take control. Reversely when we are happy, comfortable then system 1 take control.

So that we need to understand our mood while making any investment decision. If we are in good mood then our system 1 will take charge and we might not be getting involved in the proper analysis of our own decisions.

Norms, Surprises, and Causes

Assessing Normality

The main function of System 1 is to maintain and update a model of your personal world, which represents what is normal in it. The model is constructed by associations that link ideas of circumstances, events, actions, and outcomes that co-occur with some regularity, either at the same time or within a relatively short interval. As these links are formed and strengthened, the pattern of associated ideas comes to represent the structure of events in your life, and it determines your interpretation of the present as well as your expectations of the future.

When something happens or surprise our first time, when similar happens again, we will get lessor surprise or treat it as a normal. Our system 2 suggest that this is not a normal but system 1 made it. Whenever we met any surprises for the first time, our mind expects similar to happens again while a similar situation arises. That previous incident becomes normal for us and if that similar incident will not occur then we get more surprised.

It has been previously happening that market falls and get recover from that fall within 1-2 years. So that when the market falls everyone thinks that it will recover easily and we should invest. But there is a possibility that it may take a longer time to recover then what it used to be in past. So that we should not believe blindly that what has happened in past can happen in future also. It can have a higher probability to happen similar but also should not ignore the probability to not happen the same again or in the same time period.

Seeing Causes and Intentions

We generally use casual intuition frequently. For example, if someone says that he lost his wallet, then first thought comes of pickpocket rather than put somewhere, forget at restaurants, etc.

A Machine for Jumping to Conclusions

Jumping to conclusions is efficient if the conclusions are likely to be correct and the costs of an occasional mistake acceptable, and if the jump saves much time and effort. Jumping to conclusions is risky when the situation is unfamiliar, the stakes are high, and there is no time to collect more information. We should not jump to the conclusion where we know that involvement of system 2 is essential. It has a higher probability to meet error if we jump to the conclusion without taking the help of system 2.