What I find puzzling about the behavioral economists is that they don't distinguish the effects of wrong thinking and the cause of this thinking. Of course once they have an example of mental bias, ambiguity or short cut, they can easily give an illustration of how this problem occurs in investing, but seldom do they get to the root cause of the cognitive problem, they just warn you to be aware of the issue.

Take over-confidence: obviously, with 30 times leverage common in the investment banks before the crisis, it was not just an issue for small-time novice traders.

Perhaps overconfidence is self-bias or bias toward your own genes. It is natural to assume when you win it was all well deserved based on talent and hard work, when you lose it was all bad luck.

The corresponding assumption for the investor is that when you win, you were right, not lucky. The market is behaving rationally. You got your facts straight, interpreted them correctly, and your knowledge was sufficiently all encompassing.

Likewise when you lose, the market is behaving irrationally, it is being driven by irrational fear or greed and/or is not focused on the important information that you possess. Or if you lose it was simply a case of bad luck, a random event that could not be expected or planned.

This may be the basis for K's saying, “the market can stay irrational longer than you can remain solvent.”. While this saying may keep you in the game longer, by allowing you to survive and limit your losses, it is only a slightly humbler game plan. It does not allow you to learn from your competitor. It does not teach you to change your game plan.

The hope that you are “right” leaves you to hit bad drawdowns more than you should. Like in a lovers' quarrel, you won't admit your share of the blame: you hope the goodness of your partner will only allow them to stray so far before they come to their senses. If you can’t admit a mistake, no matter how small those consistent mistakes may be, sooner or latter you will find yourself alone, wondering what you did that was so bad they would leave you. So admit your mistakes. Further, if you allow that your competitor may least have some different strength than you, you can learn to individualize and incorporate the best of their knowledge into your game. It will allow you to be a student, but stay loyal to your plan, not following whomever appears to be winning the most at the moment.

Always assuming you were right, and were focused in on the right things, not simply lucky or helped by the competitor’s weak spot, causes you stay in a winning trade or strategy too long. It causes you not to improve or move from your niche before it is too late.

While I loved to win races, I always enjoyed the win more if it was a close race against stiff competition. I would rather finish second or worse, out of the money, at a competitive race, than go to a small time local race, win by a mile, and collect a couple of dollar bills. If you respect your competitor, they teach you to run better, smarter, and harder.

Likewise, for several years, I would sign-up and train for a Fall marathon, each year only to come down sick, with a cold or worse right before the race. Then I would run with a cold (if mild), or not show up. It took me a while to realize that while my taper before the race left me rested and stronger, it also lowered my immune system. It was not bad luck, but too sharp a taper before the race that consistently got me sick.

It took me a while to learn this, but if you are going to do anything with ample scale  and worth mastering, all the hard work and talent is just a necessary condition to win, but it never sufficient to encompass everything. Perfection or at least competence in small matters may be guaranteed, but true success in the overall endeavor is never guaranteed.

The first step to growing after a victory or defeat is to praise your opponent.





Speak your mind

2 Comments so far

  1. Mike Olds on October 11, 2009 12:03 pm


    How about taking the idea of bias right down to the root?

    Do you exist?

    The idea that there is or is not some kind of continuing self there, in spite of the fact that there is no evidence for such a thing to be found, dictates all the subsequent thinking of the individual. In other words, every position taken by an individual not free from the self bias, is biased.

    Do this. Take a look. Is any of that material stuff there you call ‘me’ of a nature to stand still even for a millisecond? Or the space? Or the consciousness? Is it under ‘your’ control? Can you say: Let that which is mine not change? Should you not be able to dictate to that which is ‘you’ or ‘yours’? Let me never again experience loss? Pain? If you can’t, can you really say that any part of that belongs to you?

    These are the four root biases: It is. It is not. It both is and is not. It neither is nor is not. {I am. I am not … I was … I will be}

    An example of a group holding that ‘It is,’ is Christianity; for a group that holds that it is not, Judiasm, and some schools of Buddhism that are not following the teachings of the Buddha. The prevailing bias in the US is that there both is and is not: half our mind believes in the impersonal chemical molecular nature of the world inspiring the ‘detachment’ of ‘pure’ science (the bias against the idea of a self or a creator god — which is just another way of speaking about a self); the other irrational belief that someone else’s actions can save us from the consequences of our corrupt behavior.

    How does this cause such a trading bias as overconfidence?

    Try this: In a world which is constantly changing, the subjective perception is that the self is constant.

    In a world where the self is constant and everything else is constantly changing, the conclusion reached by a believer in the rationality of logic must be that ‘I am the only one.’ This is happening ‘for’ me. This is happening ‘because’ of me. ‘I am the Creator.’ ‘The One and Only.’ The Father of all there is and all there is to be.

    And in fact, push perception to it’s point of origin and what one sees is that the coming to be in one’s world of an object (i.e., creation) occurs simultaneously with perception. It doesn’t happen any other way. Thus the conclusion ‘I am the creator.’

    Stated another way: An individual, defining himself as a being that experiences through the senses (and that includes the mind and thoughts), cannot see beyond the personal experience of the sensation: Sense object comes into contact with sense organ in the presence of consciousness and sense experience FOLLOWS in time. Hence individuals are never perceiving outside their personal world. The subjective experience is the thought that ‘I must be God the Creator.’

    You think: “Nonsense!” I am not running around here thinking I am God.

    The h*** you arn’t! [Please, impersonal ‘you’] Your behavior says it all. You have no conception of the finitude of your life. You live like you will live forever. You are completely careless of the consequences of your actions. In every way you act in complete accordance with the idea that you are the only person here that counts. The most generous of you, the most ethical behave with unbroken self-interest.

    So it’s no big deal leap of perception to see that when a decision goes the way one wishes, it confirms one’s bias, while when the results go the other way, it must be something we did or are doing wrong. This business of blaming bad luck or others doesn’t even fool the self. Take a look. We get ‘depressed’ after a loss because we are being forced to think up against this perceptual bias, and this is not something we wish to do because for the most part we don’t have a solution to the problems it raises. That doesn’t mean there are no problems. This also explains winners failure. Too much ‘good luck’ also raises the issue of why which leads back to the origin of the bias. Something we don’t want to think about.

    I suggest it’s worth thinking about.

  2. Pythagoras on October 12, 2009 6:45 am

    interesting but tip of iceberg…

    I would contribute but am busy trading for a living, plus I'm too stupid and lazy


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