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.





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