“Inspiration comes slowly and quietly.”
Why do people hold onto stocks? Why do people tend to not be able to let go? Take this short quiz from Gary Belskyand in Business 2.0, and see if you fit in with the majority.
Attila was one tough Hun — until he ran into somebody even tougher. And now, a pop quiz:
- What date do you get when you add 400 to the last three digits of your phone number?
- When was Attila finally defeated?
At first glance, these questions don’t seem to have much to do with each other, let alone with investing. But a group of academics in a growing field called behavioral economics beg to differ. How people answer off-the-wall queries like these, the behaviorists say, opens a window into how the human brain grapples with risk-and-reward trade-offs, generalizations from data, and all the other unnatural mathematical exercises that go into investing. And how well does our mental wiring serve us as investors? Adding 400 to the last three digits of your phone number obviously tells you absolutely nothing about when Attila was defeated. Yet when the two questions were put to a group of 500 MBA students, the students unconsciously acted as if it did. The students whose phone-number calculations fell between 400 and 599 had the head Hun meeting his Waterloo, on average, in A.D. 629. When the phone-number calculations came out between 1,200 and 1,399, the average guess was A.D. 988! (The real answer: A.D. 451.) The Hun exercise illustrates a subtle human tendency to glom on to one fact — relevant or not — as a reference point for decisions. The behaviorists call it anchoring. “One reason people hold on to stocks is because they’ve anchored to a purchase price as the real worth,” says Cornell behavioral science professor J. Edward Russo. “Or they dump a mutual fund because it only earned 7 percent last year, having anchored on to much higher annual return figures common in the past decade.” In bull markets, Russo says, “we tend to look at hefty annual returns and expect more of the same, while in bear markets we focus on recent bad numbers and become overly pessimistic and conservative.” What to do? To free yourself from this kind of thinking, you need to raise it to consciousness.
Anchoring. Loss aversion. On to the next quiz:
- Give high and low estimates for the average weight of an empty Boeing 747 aircraft. Choose numbers far enough apart to be 90 percent certain that the true answer lies somewhere in between.
- Now give high and low estimates for the diameter of the Earth’s moon in miles. Again, choose numbers far enough apart to be 90 percent certain that the true answer lies somewhere in between.
When Russo offered these and eight similar questions to more than 1,000 businesspeople, the majority missed four to seven of them, failing to give ranges that included the real answers — 399,000 pounds and 2,155 miles, in our examples. There was nothing to stop anyone from playing it ultrasafe with a range of, say, 1 to 1 billion. Yet few did. In such situations, Russo says, arrogant and insecure people alike are reluctant to admit how little they know. It’s called, simply, overconfidence. A startling example popped up in another discount-brokerage study by Odean and colleague Brad Barber. From 1991 through 1996, the average household earned annualized returns of 17.7 percent. But the 20 percent of households that traded the most — turning over 9.6 percent of their portfolios monthly compared with 6.6 percent for the average household at the firm — averaged an annual return of just 10 percent. In other words, the most confident investors (a reasonable assumption to make about heavy traders) posted results far below those of less-sure investors. What to do? Simple: Trade less often.
Trend Following Products
Review trend following systems and training:
More info here.