Wiki - Emotions and Investing (new investors - read this)

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Wiki - Emotions and Investing (new investors - read this)

Postby LadyGeek » Thu Jul 18, 2013 8:35 pm

The wiki editors have collaborated to incorporate a much-needed update- the influence of emotions on investing. Investing is not just working with numbers, the way you think also influences your investment decisions.

Called "behavioral finance," it's a subject which impacts all investors. Emotional influences can be subtle and have severe ramifications if they are not recognized in time and allowed to go unchecked.

How do you avoid stumbling into these behavioral pitfalls? By recognizing when you're about to encounter one and taking the necessary steps to avoid it. This subject is so important, that we've put it in the Bogleheads Investing Start-up kit.

Start reading here: Bogleheads® investing start-up kit (Avoid common behavioral pitfalls)

Then go to: Behavioral pitfalls

Behavioral pitfalls has been completely revised and is now broken into two sections. The first section is for new investors- it should be clearly understood. If it's not, please post a comment and explain why.

The second section will be a deep-dive into the background and theory of behavioral finance. This is the section for those who want to go further and will be more "technical." The wiki editors are still collaborating on this section, so we're not showing any content right now.

Comments / questions / concerns are welcome.

(FYI: Several wiki editors are working on this project - I'm just the messenger.)
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Re: Wiki - Emotions and Investing (new investors - read this

Postby House Blend » Fri Jul 19, 2013 9:13 am

Disagreements about something already enshrined and endorsed elsewhere are probably not what you are looking for, but I feel the need to butt in.

Gamblers fallacy
A belief that the probability of an outcome has changed when it actually has stayed the same. If a coin is flipped 10 times and lands on "heads" every time, a person employing gambler's fallacy thinks the probability of the coin landing on "heads" the 11th time will be very low. In fact, the probability of a coin being "heads" or "tails" is 50% every time the coin is flipped. The probability remains the same. Some investors may sell a stock because they don’t think it will continue to go up, while others may hold onto a declining stock thinking further declines are improbable.

This cure is worse than the disease.

"Apple is way down, so it's due to come back up."

This may or may not be a good reason to buy Apple, but of all the reasons why it might be bad, the fact that coin flips are unaffected by past history should not even be on the list.

What is dangerous for an investor is the notion that market movements can be modeled by coin flips, or in fact any probabilistic model.

But once you've committed that sin, there's nothing particularly invalid about assuming that what happens next is dependent in part on past history.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Quasimodo » Fri Jul 19, 2013 9:24 am

As someone who has managed to sabotage himself many times while investing, I want to give a big "Thank you!" to Lady Geek and the editors of this section of the website.

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Re: Wiki - Emotions and Investing (new investors - read this

Postby MathWizard » Fri Jul 19, 2013 1:08 pm

Excellent!

The first book on investing that I read had a full chapter on emotions. Being a numbers guy,
I thought it was strange at the time, and the least useful part of the book.
(Perhaps this was Overconfidence?: I would NEVER make a financial decision based on emotions!)

I have come to understand how powerful and potentially ruinous emotions
can be on investments.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby pkcrafter » Sat Jul 20, 2013 8:40 am

House Blend, I'm not sure if you are objecting to the coin flip example or the investing example. The coin flip is used in many definitions/examples of gambler's fallacy and the investor example's give away is the word "due". A stock is down and is due for a good gain. The market has had a good run up and is due for a down turn.

Here's the classic example of expected odds--the Monte Carlo fallacy

http://en.wikipedia.org/wiki/Monte_Carlo_Casino

also referred to as the fallacy of the maturity of chances, is the belief that if deviations from expected behaviour are observed in repeated independent trials of some random process, future deviations in the opposite direction are then more likely.


http://www.investopedia.com/terms/g/gamblersfallacy.asp

On more using an example by Larry S.

http://moneyover55.about.com/od/howtoinvest/a/Gamblers-Fallacy-Learn-To-Be-A-Better-Investor-Through-Behavioral-Finance.htm

House Blend wrote:
But once you've committed that sin, there's nothing particularly invalid about assuming that what happens next is dependent in part on past history.


What happens to the market in the short term is random and thinking you can assume what is likely to happen next is a fallacy. Is it due? Are you going to bet on it.

Paul
Last edited by pkcrafter on Sat Jul 20, 2013 3:42 pm, edited 1 time in total.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby livesoft » Sat Jul 20, 2013 10:04 am

LadyGeek wrote:Comments / questions / concerns are welcome.

(FYI: Several wiki editors are working on this project - I'm just the messenger.)

Thanks for this. I believe reading behavioral finance books was one of the best things I have ever done for my investing life. The article references only Zweig's book which I do not consider the best book for folks new to the topic.

I think it would be helpful to add "For further reading" a short list of books. Zweig's book would be on the list, but I would put the Gilovich and Belsky "Why Smart People Make Big Money Mistakes" at the top. This book is listed in the left-hand panel at http://www.bogleheads.org which is very helpful. The list at http://www.bogleheads.org/readbooks.htm is a suitable order. Ariely's "Predictably Irrational" could go on the list, too.

I came away from reading Zweig's book with "That's nice, but what do I do about what I just read" while the Gilovich and Belsky book had some specific advice. The latter is also simpler and easier to get through.

The more general but not necessarily focussed on investing Kahneman's "Thinking, Fast and Slow" should be listed as well.

Anyways, just some comments as requested. Thanks for reading.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Sat Jul 20, 2013 10:50 am

Thanks for the suggestion, I updated the wiki: Behavioral pitfalls

BTW, all wiki editors are welcome to edit this page. Post here if you make any updates.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Sat Jul 20, 2013 11:05 am

livesoft wrote:
LadyGeek wrote:Comments / questions / concerns are welcome.

(FYI: Several wiki editors are working on this project - I'm just the messenger.)

Thanks for this. I believe reading behavioral finance books was one of the best things I have ever done for my investing life. The article references only Zweig's book which I do not consider the best book for folks new to the topic.

I think it would be helpful to add "For further reading" a short list of books. Zweig's book would be on the list, but I would put the Gilovich and Belsky "Why Smart People Make Big Money Mistakes" at the top. This book is listed in the left-hand panel at http://www.bogleheads.org which is very helpful. The list at http://www.bogleheads.org/readbooks.htm is a suitable order. Ariely's "Predictably Irrational" could go on the list, too.

I came away from reading Zweig's book with "That's nice, but what do I do about what I just read" while the Gilovich and Belsky book had some specific advice. The latter is also simpler and easier to get through.

The more general but not necessarily focussed on investing Kahneman's "Thinking, Fast and Slow" should be listed as well.

Anyways, just some comments as requested. Thanks for reading.


Livesoft,

Agreed about the further references, in particular the ones you name and more, and I'm sure that will happen.

As for Zwieg's book, Your Money and Your Brain, it is not strictly behavioral finance but neuroscience, another relatively new field: as he explains, "a hybrid of neuroscience, economics, and psychology." It's understanding investing behavior as a "basic biological function."

Zweig does list what to do throughout the book. In the chapter on "Fear," for example, he lists ways to fight fears. In the chapter on "Risk," he suggests such things as "Write Yourself a Policy," "Try to Prove Yourself Wrong," "Know Yourself," etc.

The subject of Zweig's book may seem advanced for new investors, but his writing is easy to read for almost anyone I think. The book begins, "How could I have been such an idiot?" I think that speaks to most of us (definitely to me). But I agree about Gilovich and Belsky also being used.
Last edited by Fallible on Sat Jul 20, 2013 12:17 pm, edited 1 time in total.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby nedsaid » Sat Jul 20, 2013 11:27 am

The behavioral pitfalls is the best primer on emotions and investing that I have read. It is an accurate description of the emotional traps we all face as investors.

To be a successful investor, you have to be willing to do things others are not willing to do. It also means doing things that you don't "feel like" doing.

First is the willingness to save, when the culture screams at you to spend and to keep up with friends and neighbors. You have to go against the flow of your emotions. Recently, I did some mild rebalancing selling stocks to buy bonds. I don't like trimming something that has done well to buy something that hasn't done well, but I do it because it is good for me.

Back in 2008, I had to fight feelings of fear to buy stocks with 100% of new monies available for investment. I should have sold bonds to buy stocks but I was too scared to do this. I did the next best thing. In effect, I was buying stocks from my fellow employees that were selling. In effect, a transfer of wealth from them to me if I was patient enough for markets to rebound.

There are times you frustrated with a disappointing investment. You wait and wait and wait and finally sell only to see it go up right after you sell. I think this is what James Cramer meant by making a sacrifice to the trading Gods. There are times to sell, obviously, but most of the time the best thing to do is nothing. Investments don't care whether you are frustrated with them or not.

There is also the element of discipline, which in many segments of our culture is not valued. Sticking with the plan even though everything in you wants to tinker with the portfolio. Sticking with the tried and true and the boring when your emotions want to chase the "hot" investments. Index funds are boring and they make for boring conversation at parties. But boring and dull can be immensly profitable.

The markets are a very poor place to seek validation, get that from spouse, family, and friends. Markets could care less about your self-esteem. If anything, they can be very humbling. Markets are a terrible place to seek excitement. When emotions run hot, decision making decreases in quality. The financial markets are also a terrible place for your competitive instincts. People exaggerate their investing prowess and don't tell you about their investing disappointments. It is a losing game to compete against someone else's exaggerated stories.

Steady as she goes. Stay off the emotional roller coaster best you can. Be willing to do things that emotionally you don't want to do.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby House Blend » Sat Jul 20, 2013 2:17 pm

pkcrafter wrote:House Blend, I'm sure if you are objecting to the coin flip example or the investing example. The coin flip is used in many definitions/examples of gambler's fallacy and the investor example's give away is the word "due". A stock is down and is due for a good gain. The market has had a good run up and is due for a down turn.

Just because something is random doesn't mean that it isn't influenced by past history. (Ex: playing blackjack, if you know that the proportion of 10-counts remaining in the deck is high, then you know something that should alter your betting strategy relative to what you would use for a fresh deck.)

I'll try to restate what I'm objecting to in another way.

If you define Gambler's Fallacy as the (mistaken) belief that prior coin flips (or independent trials) have an effect on the next coin flip (or trial), then I'm fine with that.

Certainly any gambler that doesn't understand this is in trouble.

Where I have bones to pick are:
a) whether this has any relevance to investing,
b) whether this is relevant to all probabilistic models of market movements, however misguided those may be.

The example I quoted from the wiki involves two investor types, one who looks at past past history and sells, and one who looks at past history and holds. As far as I can tell, we are supposed to conclude that both investors are falling victim to the Gambler's Fallacy trap.

This makes no sense. In fact, I would argue that whoever wrote that paragraph is a victim of the "All sequences of events are independent" Fallacy.

To wit, Gambler's Fallacy only applies to sequences of independent trials. And one thing that is certain in investing is that price movements are dependent on participants, and participants are aware of past history. Investors may have strategies based on momentum or contrarianism, and I have no opinion on whether these strategies have merit, but they do rely on past history. And plenty of perfectly valid probabilistic models in other fields of endeavor rely on past history (see, e.g., the theory of Markov chains).

That price movements of stocks are independent of past history is a rather extraordinary and dubious claim. If it were true, there would be no fat tails.

In any case, I think a much more dangerous fallacy is the misguided belief that market movements can be modeled probabalistically in a way that leads to useful, actionable strategies. At least for time-scales relevant for us; I'm agnostic about what can be done at the time scales used by HFTs.
What happens to the market in the short term is random and thinking you can assume what is likely to happen next is a fallacy. Is it due? Are you going to bet on it.

This comment from you sounds actually like we are not that far apart. If I understand where you are coming from correctly, then I can explain what I am objecting to by saying that the offending paragraph makes it sound like there is a valid probabilistic model for market movements, and that this "correct" model implies that momentum and contrarianism don't work.

I think we both agree that there isn't a "correct" probabilistic model.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Phineas J. Whoopee » Sat Jul 20, 2013 2:34 pm

The coin flip example, IMHO, is a good one, which is not used nearly enough.

The most likely outcome of 100 flips is 50 heads and 50 tails, not taking into account the order they come in.

Ask people what they think "the most likely outcome" means.

The likelihood of 50 and 50 in any order is only 8%.

"The most likely outcome" will hardly ever happen.

Every other specific outcome is less likely, but the sum of the likelihoods of all other specific outcomes is 92%.

Only do this if you can afford to be alienated from the people you're speaking with. A couple of times I've been the subject of physical threats. I seldom respond to the gambler's fallacy with it anymore.

Maybe that's why it isn't used so often.

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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Sat Jul 20, 2013 2:44 pm

House Blend wrote:
pkcrafter wrote:House Blend, I'm sure if you are objecting to the coin flip example or the investing example. The coin flip is used in many definitions/examples of gambler's fallacy and the investor example's give away is the word "due". A stock is down and is due for a good gain. The market has had a good run up and is due for a down turn.

Just because something is random doesn't mean that it isn't influenced by past history. (Ex: playing blackjack, if you know that the proportion of 10-counts remaining in the deck is high, then you know something that should alter your betting strategy relative to what you would use for a fresh deck.)

I'll try to restate what I'm objecting to in another way.

If you define Gambler's Fallacy as the (mistaken) belief that prior coin flips (or independent trials) have an effect on the next coin flip (or trial), then I'm fine with that.

Certainly any gambler that doesn't understand this is in trouble.

Where I have bones to pick are:
a) whether this has any relevance to investing,
b) whether this is relevant to all probabilistic models of market movements, however misguided those may be.


And then there is the coin experiment with Doctor John and Fat Tony. Even after getting 99 out of 100 tosses as heads, Dr. John insists that the probability of the next one is fifty-fifty. He is so brainwashed by the text-book probability models that he cannot distinguish them from the reality.

Fat Tony, on the other hand, is street-smart. He sees what he sees, and the models be damned. He sees what he sees, and the statement "Assume a fair coin" be damned.

Victoria
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Phineas J. Whoopee » Sat Jul 20, 2013 3:53 pm

I'm about 1/3 of the way through Antifragile now. So far it's made good points, but the constant political and pseudoscientific zingers are irritating. He says upfront it's an essay, not a research paper, which is OK. But after that he says all research papers are worthless (but later he excepts physics research papers as a special case [as special cases? Do plurals even matters anymores?]).

Probably all Big Pharma's fault. Or so he's claimed. Maybe he pulls it all together later.

I have to finish within a week and get it back to the library, lest it be fine.

d

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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Sat Jul 20, 2013 4:02 pm

Phineas J. Whoopee wrote:I'm about 1/3 of the way through Antifragile now. So far it's made good points, but the constant political and pseudoscientific zingers are irritating. He says upfront it's an essay, not a research paper, which is OK. But after that he says all research papers are worthless (but later he excepts physics research papers as a special case [as special cases? Do plurals even matters anymores?]).

His focus is pluralism, not plurals.

Phineas J. Whoopee wrote:Probably all Big Pharma's fault. Or so he's claimed. Maybe he pulls it all together later.

I have to finish within a week and get it back to the library, lest it be fine.

d

PJW


I now see antifragility wherever I look. It provides a good excuse for mishaps and failures.

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Re: Wiki - Emotions and Investing (new investors - read this

Postby Phineas J. Whoopee » Sat Jul 20, 2013 4:03 pm

VictoriaF wrote:...
I now see antifragility wherever I look. It provides a good excuse for mishaps and failures.
Victoria

I'm all in!
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Re: Wiki - Emotions and Investing (new investors - read this

Postby pkcrafter » Sat Jul 20, 2013 6:53 pm

From the posted definition:
Some investors may sell a stock because they don’t think it will continue to go up, while others may hold onto a declining stock thinking further declines are improbable.

Maybe it would be clearer if we added 'even though the probability has not changed.' The sell/hold example can be found in many examples of gambler's fallacy.

The key to gamblers fallacy is that an investor believes odds have changed when they actually did not change. In the blackjack example, the odds have changed.

Gambler's Fallacy: the mistaken belief that a run of specific results in a random process must revert


example:
Let’s assume that the S&P has closed to the upside five trading sessions in a row. You place a short trade on the SPDR S&P 500 (ARCA:SPY) because you believe chances are high that the market will drop on the sixth day. While it may happen, on a purely statistical basis, the past events don’t connect to future events. There may be other reasons why the sixth day will produce a down market; but by itself, the fact that the market is up five consecutive days is irrelevant.


http://www.investopedia.com/articles/investing/051613/behavioral-bias-cognitive-vs-emotional-bias-investing.asp

Readers may find this interesting--

Positive and negative recency are both observable in normal human behaviour. Perhaps the most common forms of these appear in the “hot-hand effect” and the “gambler’s fallacy” respectively. In the former people erroneously believe that players in certain sports get on a roll and demonstrate a run of success over and above what they’d normally achieve. In the latter there’s an expectation that a run of a particular type in a random process makes a reversion more likely – so a run of red on a roulette wheel makes black more likely next time.

In fact people can demonstrate both positive and negative recency at the same time about the same thing.


http://www.psyfitec.com/2010/04/recency-hot-hands-and-gamblers-fallacy.html
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Re: Wiki - Emotions and Investing (new investors - read this

Postby House Blend » Sun Jul 21, 2013 4:46 pm

Looks like my message is not getting through. I'll try again, but may have to give up on further attempts.

pkcrafter wrote:From the posted definition:
Some investors may sell a stock because they don’t think it will continue to go up, while others may hold onto a declining stock thinking further declines are improbable.

Maybe it would be clearer if we added 'even though the probability has not changed.'

No, this would make it worse.

It is very dangerous to draw analogies between investing and casino gambling, and that's one of the problems here.

If there has been a string of reds at the roulette table, and now a majority of the participants believes that black is overdue, then no amount of wishful thinking or dollars wagered has any effect on the next spin.

Nothing like that is true in the investing world. If enough traders believe that a stock price should increase, and act on those beliefs, then the demand will go up and the price *will* increase. (As Graham has said, in the short run the market is a voting machine; in the long run, a weighing machine.)

Again, to say that the probabilities have not changed in the investing examples is an extraordinary claim, one not supported by the way markets are constructed.

Gambler's Fallacy: the mistaken belief that a run of specific results in a random process must revert

I can live with that statement, because it doesn't commit the blunder of assuming that all random processes are not influenced by past history.

A priori one has to assume that stock prices are influenced by all the information available to traders. That information includes past history, as well as whatever nonsense Cramer is spouting on CNBC.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Sun Jul 21, 2013 7:57 pm

Let me take an inexperienced venture into this. Appendix A of Kahneman's Thinking, Fast and Slow is a copy of "Judgment under Uncertainty: Heuristics and Biases" by Amos Tversky and Daniel Kahneman, which appeared in Science, vol. 1985, 1974. I hope I get this right, if not please correct me:

In that article, the gambler's fallacy is discussed under the section titled Misconceptions of Chance. They discuss the sequence of coin flips, but then follow with a roulette wheel analogy.

The key point is that people expect that a sequence of events generated by a random process will represent the essential characteristics of that process, even when the sequence is short. After observing a long run of red, people will erroneously believe that black is "due" simply because the occurrence of black is a more representative sequence than the occurrence of an additional red. Chance is commonly viewed as a self-correcting process in which a deviation in one direction induces a deviation in the opposite direction to restore the equilibrium. In fact, deviations are not "corrected" as the chance process unfolds, they are merely diluted.

They then go into the "law of small numbers" which is another subject unto itself.

As to the relationship to behavioral finance, I think this sways the opinion towards House Blend, but I'm not sure.

Update: Corrected roulette example.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby pkcrafter » Sun Jul 21, 2013 9:16 pm

I do not wish to debate this further either. If editors want to change the example, It's fine. I am familiar with the roulette example, but the investor example sounds the same, only it's related to investing.

House Blend wrote:
If there has been a string of reds at the roulette table, and now a majority of the participants believes that black is overdue, then no amount of wishful thinking or dollars wagered has any effect on the next spin.

Nothing like that is true in the investing world. If enough traders believe that a stock price should increase, and act on those beliefs, then the demand will go up and the price *will* increase. (As Graham has said, in the short run the market is a voting machine; in the long run, a weighing machine.)

Again, to say that the probabilities have not changed in the investing examples is an extraordinary claim, one not supported by the way markets are constructed.


The example in Gamblers fallacy is the same as the roulette wheel example. It's not about the market, it's about how investors think about the market. Also, the market is random in the short term, there are no useful patters or useful historical data.

Here's the reference:

Gambler's Fallacy In Investing
It's not hard to imagine that under certain circumstances, investors or traders can easily fall prey to the gambler's fallacy. For example, some investors believe that they should liquidate a position after it has gone up in a series of subsequent trading sessions because they don't believe that the position is likely to continue going up. Conversely, other investors might hold on to a stock that has fallen in multiple sessions because they view further declines as "improbable". Just because a stock has gone up on six consecutive trading sessions does not mean that it is less likely to go up on during the next session.


Investopedia reference:

http://www.investopedia.com/university/behavioral_finance/behavioral7.asp
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Re: Wiki - Emotions and Investing (new investors - read this

Postby siamond » Sun Jul 21, 2013 9:49 pm

Very nice job from the editors. I found all terms to be very clearly explained. Not to say I will not fall (again) in one of those traps (heck, I'm holding on FB as we speak... loss aversion?), but you guys did a real nice job of educating us to at least be aware of those pitfalls. Thank you.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Sun Jul 21, 2013 10:13 pm

^^^ You're welcome (from the editors).

After reading everyone's comments on the gambler's fallacy, I think the wiki should be updated. Would this work? The footnote leaves out a lot of detail, but I think a new investor will get the main point - which is the intention here.

A mistaken belief that a sequence of prior events will have a different outcome on the next event. An investor may wish to sell a stock because the price has risen for the past 5 days and it's "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.*

*It's called the Gamblers Fallacy because the effect is analogous to betting on a coin toss, e.g. predicting a tails outcome when the outcome of the previous 5 flips was all heads.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Mon Jul 22, 2013 6:22 am

There are several types of fallacies here:

1. Pure gambler's fallacy
When dealing with a pure random process, a gambler sees patterns and expects the reversion to the mean where these do not exist.

2. Doctor John's fallacy
Assuming text-book probability examples where they do not apply in real life, being blinded by the stated assumptions such as "assume a fair coin."

3. Magnitude fallacy
Purely random scenarios are always artificial ones, i.e., created by experimenters or gambling establishments. In these scenarios the magnitudes of outcomes are known and computable. In natural environments, such as financial markets, not only the direction is unknown a priori but also the magnitude of the move in that direction is unknown.

4. Definition fallacy
Assuming that definitions created in one context are applicable to other contexts. For example, "gambler's fallacy" is a legitimate name for processes that are truly random, such as Kahneman's experiments and such as typical gambling scenarios. However, financial markets are not purely random. The expression "gambling in the markets" is a good metaphor, but it's dangerous to extend controlled-experimental findings to metaphors.

So where does it lead us to in the context of investing? Here is how I would describe the gamblers fallacy to the Bogleheads:

    "While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the pure gambling, the gambler's fallacy is to consider that the coin, or the roulette table, or the lottery machine has memory. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future."

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Re: Wiki - Emotions and Investing (new investors - read this

Postby House Blend » Mon Jul 22, 2013 7:14 am

LadyGeek wrote:After reading everyone's comments on the gambler's fallacy, I think the wiki should be updated. Would this work? The footnote leaves out a lot of detail, but I think a new investor will get the main point - which is the intention here.

A mistaken belief that a sequence of prior events will have a different outcome on the next event. An investor may wish to sell a stock because the price has risen for the past 5 days and it's "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.*

*It's called the Gamblers Fallacy because the effect is analogous to betting on a coin toss, e.g. predicting a tails outcome when the outcome of the previous 5 flips was all heads.


What I'd rather see is a deletion of any analogies with casino gambling--whether idealized, or corrupted by practical realities. Stock price movements are not a sequence of independent trials.

pkcrafter wrote:Also, the market is random in the short term, there are no useful patters or useful historical data.

I can agree with the bolded part--it's different from saying that the probabilities have not changed.

It seems non-controversial to say that humans are poor at detecting biases in streams of data, and expert at finding patterns that aren't there. And that to me seems closer to the heart of whatever lesson about Emotional Investing is intended by the Gambler's Fallacy paragraph.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby livesoft » Mon Jul 22, 2013 10:11 am

Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Mon Jul 22, 2013 10:23 am

livesoft wrote:Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?


Interesting. Can you expand on that, provide an example?
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Re: Wiki - Emotions and Investing (new investors - read this

Postby pkcrafter » Mon Jul 22, 2013 10:47 am

livesoft wrote:Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?


It appears that even the pro's can't take advantage of investor's behavioral mistakes.

Link to a recent study: Did Behavioral Mutual Funds Exploit Market Inefficiencies During the Crisis?

http://www.mfsociety.org/modules/modDashboard/uploadFiles/conferences/MC20~38~p17d0ormjga7u1krk1m956aer1e4.pdf

To save you some work, the answer is NO.

What I really find interesting is the inclusion of a fund called Undiscovered Managers Behavioral Value Inst. Fund. This fund is advised by the well-known behavioral economist Richard Thaler. The fund has an ER of 1.39%. Has Thaler learned nothing?

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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Mon Jul 22, 2013 8:11 pm

Taking VictoriaF's statement:
VictoriaF wrote:While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the pure gambling, the gambler's fallacy is to consider that the coin, or the roulette table, or the lottery machine has memory. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

Then, removing all aspects of casino gambling and inserting an example, I get:

The gambler's fallacy assumes that an individual investor can detect patterns in market behavior and project them into the future. Guessing the direction and magnitude of the price movement for the next moment is similar to gambling. An investor may wish to sell a stock because the price has risen for the past 5 days and it's "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

If this doesn't work, I'm stuck.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Mon Jul 22, 2013 8:51 pm

LadyGeek wrote:Taking VictoriaF's statement:
VictoriaF wrote:While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the pure gambling, the gambler's fallacy is to consider that the coin, or the roulette table, or the lottery machine has memory. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

Then, removing all aspects of casino gambling and inserting an example, I get:

The gambler's fallacy assumes that an individual investor can detect patterns in market behavior and project them into the future. Guessing the direction and magnitude of the price movement for the next moment is similar to gambling. An investor may wish to sell a stock because the price has risen for the past 5 days and it's "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

If this doesn't work, I'm stuck.


Hi LadyGeek,

I propose combining your and my text as follows:

    In the common gambling scenarios, the gambler's fallacy is thinking that the coin, or the roulette, or the lottery machine has memory, and that a long streak of the same values is unnatural and must end by reverting to other values.

    While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

    For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

Victoria
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Re: Wiki - Emotions and Investing (new investors - read this

Postby MathWizard » Mon Jul 22, 2013 8:54 pm

livesoft wrote:Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?


This is useful; only if you are not going to buy and hold.
Is that case, I would use the following three quotes:

Be fearful when others are greedy, and greedy when others are fearful - Buffet

When you get stock tips from shoeshine boys, get out of the market. - Attributed to Joe Kennedy

In the short term the market is a voting machine, in the long term it is a weighing machine. - Attributed to Ben Graham by Buffet

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The 3rd is to invest for value. That does assume you know how to weigh rather than vote.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Mon Jul 22, 2013 9:15 pm

VictoriaF wrote:Hi LadyGeek,

I propose combining your and my text as follows:

    In the common gambling scenarios, the gambler's fallacy is thinking that the coin, or the roulette, or the lottery machine has memory, and that a long streak of the same values is unnatural and must end by reverting to other values.

    While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

    For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

Hi VictoriaF,

I agree with your wording (and one word struck out). Any further simplification would distort the meaning.* Do we have a consensus?

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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Mon Jul 22, 2013 11:59 pm

LadyGeek wrote:
VictoriaF wrote:Hi LadyGeek,

I propose combining your and my text as follows:

    In the common gambling scenarios, the gambler's fallacy is thinking that the coin, or the roulette, or the lottery machine has memory, and that a long streak of the same values is unnatural and must end by reverting to other values.

    While financial markets are not truly random, from the individual investor's point of view, they behave in a random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

    For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

Hi VictoriaF,

I agree with your wording (and one word struck out). Any further simplification would distort the meaning.* Do we have a consensus?

*Everything Should Be Made as Simple as Possible, But Not Simpler -- attributed to Albert Einstein.


Not arguing accuracy here, but in thinking of our reader, I have some questions: In the first sentence, is the reader, i.e., a new investor or perhaps one not yet even invested, going to easily understand what it means? Will they know what "memory" means? What "unnatural" means? In the second sentence, will they immediately understand what is meant by markets being not truly random even though investors think it is? Note also that we have told them the market is random in the definition of "Overconfidence." We're okay there, but it could add to their confusion. Could these sentences be written closer to their level of experience?
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Tue Jul 23, 2013 6:28 am

Fallible wrote:Not arguing accuracy here, but in thinking of our reader, I have some questions: In the first sentence, is the reader, i.e., a new investor or perhaps one not yet even invested, going to easily understand what it means? Will they know what "memory" means? What "unnatural" means? In the second sentence, will they immediately understand what is meant by markets being not truly random even though investors think it is? Note also that we have told them the market is random in the definition of "Overconfidence." We're okay there, but it could add to their confusion. Could these sentences be written closer to their level of experience?


Hi Fallible,

I think new investors start with the basics of investing such as asset allocation, use of broad-based low-cost index funds, and re-balancing. They also ask specific questions related to their current investments, 401(k) options and alike.

The behavioral stuff is more advanced, and by the time investors are ready for it they are not "new." If they have participated in Bogleheads discussions, they know how to search for information and ask questions.

I am uncomfortable with popularizing definitions because it frequently turns off sophisticated readers and confuses lay ones. Examples, on the other hand, are very useful. I think LadyGeek provided very good ones.

What do you think?

Victoria
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Barry Barnitz » Tue Jul 23, 2013 7:07 am

Hi:

Additional possible wordsmithing:
In the common gambling scenarios, the gambler's fallacy is thinking a belief that the coin, or the roulette, or the lottery machine has memory, and somehow knows about and will try to fix the fact that a long streak of the same values (such as heads, or red numbers) is unnatural and must end by reverting to other values (tails, or black numbers).

While financial markets are not truly random, From the individual investor's point of view,they momentary price changes behave in a seemingly random fashion. At any given moment, market prices represent the best available information, and guessing the direction and magnitude of the price movement for the next moment is similar to gambling. In the market gambling, the gambler's fallacy is to assume that an individual investor can discern the patterns of the market behavior and project them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.


edit: wordsmithed "memory" and financial section
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 7:27 am

VictoriaF wrote:
Fallible wrote:Not arguing accuracy here, but in thinking of our reader, I have some questions: In the first sentence, is the reader, i.e., a new investor or perhaps one not yet even invested, going to easily understand what it means? Will they know what "memory" means? What "unnatural" means? In the second sentence, will they immediately understand what is meant by markets being not truly random even though investors think it is? Note also that we have told them the market is random in the definition of "Overconfidence." We're okay there, but it could add to their confusion. Could these sentences be written closer to their level of experience?


Hi Fallible,

I think new investors start with the basics of investing such as asset allocation, use of broad-based low-cost index funds, and re-balancing. They also ask specific questions related to their current investments, 401(k) options and alike.

The behavioral stuff is more advanced, and by the time investors are ready for it they are not "new." If they have participated in Bogleheads discussions, they know how to search for information and ask questions.

I am uncomfortable with popularizing definitions because it frequently turns off sophisticated readers and confuses lay ones. Examples, on the other hand, are very useful. I think LadyGeek provided very good ones.

What do you think?

Victoria


Hi Victoria,

What I think is, hopefully, what our reader thinks.

We’re at the wiki's “Start-up Kit” level here, trying to appeal to and be understood by readers who are new to investing, or who have not yet begun investing. The two sentences I’m referring to are beautifully written (I would expect no less from their author), but at a fairly sophisticated level that would appeal most to those already familiar with the “fallacy” and what it means for them as investors.

I’m also thinking that, because the most complex topics can be written for almost any level of reader without compromising their meaning, that this could be done here.

Fallible
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Re: Wiki - Emotions and Investing (new investors - read this

Postby nisiprius » Tue Jul 23, 2013 8:50 am

Looks fine to me, short sweet summaries of things people ought to know about.

In a general sort of way, I have a problem with the concepts themselves. It's interesting to know this stuff, but I'm not sure that knowing it actually helps you invest any better. And worse yet, too most of the stuff I read about behavioral errors reminds me of contradictory proverbs--"He who hesitates is lost/Look before you keep."

For example, if I do what everyone else does and it turns out badly, I'll be blamed for showing "herd behavior." But, if I take off on my own and it turns out badly, I'll be told that I was guilty of "overconfidence."

The "loss aversion" description is interesting because I don't understand why it is irrational! Of course, the example shown is artificial because it involves a size of loss or gain that is many orders of magnitude smaller than anything that is typically in stake in "investing." If you scale them up to something reasonable, why couldn't this just be a perfectly accurate assessment of the investor's personal utility function? Furthermore, since many measurable life consequences are highly nonlinear with wealth, why couldn't it even be perfectly rational on a quantitative basis? Why should the rational investor regard a gain of $500,000 as the same as a loss of $500,000, when a loss of $500,000 might mean losing the house and not being able to send your kids to college, while a gain of $500,000 might mean being able to add a dormer and being able to send the kids to Stanford instead of Berkeley?

But, of course, that is a quibble with the concept, not with the Wiki article.

P.S. Also, I think it may be blaming the victim to call these "behavioral pitfalls" when in many cases a salesperson may be intentionally evoking these very factors. When I was younger and even more foolish, I paid attention to advice I got from my Merrill Lynch broker. After a while, I cottoned on to what I was doing. He would begin by asking me a delicately probing question--designed to find out what I was naturally inclined to do or wanted to do. Then, whatever I said, he would run with it, praising my wisdom and perspicacity, giving all sorts of rationales further reinforcing what I said, and then suggest investments that would do well if I were correct. It is not really fair to call this confirmation bias on my part. I was not seeking information that confirmed my preexisting opinions. Not at all. It was "confirmation" that was being manufactured by the broker, not information I was seeking, information that was being pushed to me, in order to manipulate me.

Is it just a "behavioral pitfall" when someone is pushing me into the pit?
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 9:32 am

nisiprius wrote:Looks fine to me, short sweet summaries of things people ought to know about.

And those things are emotions and biases they ought to know about before they begin investing, which was a key emphasis here.

In a general sort of way, I have a problem with the concepts themselves. It's interesting to know, but I'm not sure that knowing it actually helps you invest any better. ...

The hope stated by Kahneman, Ariely, Zweig, etc., is that by becoming aware of behavioral and emotional pitfalls, one can begin to deal with them. For some, that will work; for some others it may not.

For example, if I do what everyone else does and it turns out badly, I'll be blamed for showing "herd behavior." But, if I take off on my own and it turns out badly, I'll be told that I was guilty of "overconfidence."

Your reasons for going on your own would not necessarily result from overconfidence, but perhaps just mistaken reasoning, or bad information, etc.

The "loss aversion" description is interesting because I don't understand why it is irrational! Of course, the example shown is artificial because it involves a size of loss or gain that is many orders of magnitude smaller than anything that is typically in stake in "investing." If you scale them up to something reasonable, why couldn't this just be a perfectly accurate assessment of the investor's personal utility function? Furthermore, since many measurable life consequences are highly nonlinear with wealth, why couldn't it even be perfectly rational on a quantitative basis? Why should the rational investor regard a gain of $500,000 as the same as a loss of $500,000, when a loss of $500,000 might mean losing the house and not being able to send your kids to college, while a gain of $500,000 might mean being able to add a dormer and being able to send the kids to Stanford instead of Berkeley?

Good question! Good for discussion.

But, of course, that is a quibble with the concept, not with the Wiki article.


I have a quibble-and-a-half with the names psychologists give the concepts. I'll read about or listen to their experiments and understand them and then be told they're called something that seems totally unrelated to what I just learned, e.g., anchoring, endowment effect, availability, etc., etc. I understand that a reason Prospect Theory was chosen was because it's "catchy" and memorable. Well, the term is memorable allright, but I don't always remember what for. :shock: But that's just me and some do catch on to these terms easily.

Fallible

Edit to add "a reason" the name Prospect Theory was chosen.
Last edited by Fallible on Wed Jul 24, 2013 10:42 am, edited 1 time in total.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 9:52 am

nisiprius wrote:...
P.S. Also, I think it may be blaming the victim to call these "behavioral pitfalls" when in many cases a salesperson may be intentionally evoking these very factors. When I was younger and even more foolish, I paid attention to advice I got from my Merrill Lynch broker. After a while, I cottoned on to what I was doing. He would begin by asking me a delicately probing question--designed to find out what I was naturally inclined to do or wanted to do. Then, whatever I said, he would run with it, praising my wisdom and perspicacity, giving all sorts of rationales further reinforcing what I said, and then suggest investments that would do well if I were correct. It is not really fair to call this confirmation bias on my part. I was not seeking information that confirmed my preexisting opinions. Not at all. It was "confirmation" that was being manufactured by the broker, not information I was seeking, information that was being pushed to me, in order to manipulate me.

Is it just a "behavioral pitfall" when someone is pushing me into the pit?


If you had fallen for this common sales pitch, it could be for many reasons, some of which might be explained by one or more of the pitfalls, maybe overconfidence because it seems that's what he was hoping to appeal to and inflate. With some folks that will work, or he wouldn't be doing it. With Bogleheads, or future Bogleheads if you weren't one then, it's a waste of time. :)
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Tue Jul 23, 2013 3:32 pm

The next revision - incorporate Barry Barnitz's wording, stick to one gambling example, remove Efficient Market Hypothesis (representing best available information may be distracting here), and a bit of wordsmithing:
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

From the individual investor's point of view, price changes seem to behave in a random fashion. Guessing the direction and amount of the price change for the next moment is similar to gambling. The gambler's fallacy is where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.

Is this OK?
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 3:51 pm

LadyGeek wrote:The next revision - incorporate Barry Barnitz's wording, stick to one gambling example, remove Efficient Market Hypothesis (representing best available information may be distracting here), and a bit of wordsmithing:
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

From the individual investor's point of view, price changes seem to behave in a random fashion. Guessing the direction and amount of the price change for the next moment is similar to gambling. The gambler's fallacy is where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.


Is this OK?


Hi,

I would OK it as I believe it will be understood by our reader. So if you, Victoria, and Barry are okay with it, I certainly am and thanks to all.

Fallible
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Tue Jul 23, 2013 3:59 pm

Fallible wrote:
LadyGeek wrote:The next revision - incorporate Barry Barnitz's wording, stick to one gambling example, remove Efficient Market Hypothesis (representing best available information may be distracting here), and a bit of wordsmithing:
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

From the individual investor's point of view, price changes seem to behave in a random fashion. Guessing the direction and amount of the price change for the next moment is similar to gambling. The gambler's fallacy is where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.


Is this OK?


Hi,

I would OK it as I believe it will be understood by our reader. So if you, Victoria, and Barry are okay with it, I certainly am and thanks to all.

Fallible


There is no logical transition between the paragraph about common gambling and the paragraph about market gambling.

Victoria
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Tue Jul 23, 2013 4:22 pm

Good point. How does this look?
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

A similar perception can happen in the stock market. For example, a stock may trend in a certain direction. The investor incorrectly detects this pattern and guesses that the next move will go in the opposite direction. The investor has fallen prey to the gambler's fallacy; where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Tue Jul 23, 2013 4:27 pm

LadyGeek wrote:Good point. How does this look?


It looks better,

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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 6:50 pm

LadyGeek wrote:Good point. How does this look?
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

A similar perception can happen in the stock market. For example, a stock may trend in a certain direction. The investor incorrectly detects this pattern and guesses that the next move will go in the opposite direction. The investor has fallen prey to the gambler's fallacy; where an individual investor incorrectly detects patterns of market behavior and projects them into the future.
...


If I'm reading this right, Is it more accurate to say the investor incorrectly detects this as a pattern. There really is no pattern in these short-term trends; investors just tend to think there are - and you do go on to note that.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Tue Jul 23, 2013 7:12 pm

Yes, it is more correct - I didn't notice the omission. I also changed the wording slightly:
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long coin flipping streak of the same value (such as heads) must end by changing to the other value (tails).

A similar perception can happen in the stock market. For example, a stock may trend in a certain direction. The investor incorrectly detects this as pattern and guesses that the next move will go in the opposite direction. The investor has fallen for the gambler's fallacy; where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Fallible » Tue Jul 23, 2013 8:16 pm

LadyGeek wrote:Yes, it is more correct - I didn't notice the omission. I also changed the wording slightly:
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long coin flipping streak of the same value (such as heads) must end by changing to the other value (tails).

A similar perception can happen in the stock market. For example, a stock may trend in a certain direction. The investor incorrectly detects this as pattern and guesses that the next move will go in the opposite direction. The investor has fallen for the gambler's fallacy; where an individual investor incorrectly detects patterns of market behavior and projects them into the future.

For example, an investor may wish to sell a stock because the price has risen for the past 5 days and it is "due" for a drop. Alternatively, an investor might want to hold onto a stock because the price has dropped for the past 5 days and it can't possibly get any lower.



A bit more editing mainly to streamline:

2nd graf: just suggested tightening and also to add "a" after "as":

A similar perception can happen when a stock trends in a certain direction and the investor incorrectly detects this as a pattern and guesses it will next go in the opposite direction. The investor has fallen for gambler's fallacy, incorrectly detecting patterns of market behavior and projecting them into the future.

3rd graf: to add "and he thinks" and to tighten a bit and italicize "sell" and "hold onto" for emphasis:

For example, an investor may wish to sell a stock because the price has risen the past 5 days and he thinks it's now "due" for a drop. Or, he might want to hold onto a stock because the price has dropped the past 5 days and he now thinks it can't possibly get lower.
"Common sense and a sense of humor are the same thing, moving at different speeds. A sense of humor is just common sense, dancing." -William James
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Quasimodo » Tue Jul 23, 2013 8:27 pm

livesoft wrote:Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?


http://en.wikipedia.org/wiki/Martingale_(betting_system)

Hi Livesoft.

Is the “Anti-Martingale” example at the end of the article along the lines of what you meant?

(Just curious. I'm not trying to advocate this obviously un-Boglehead strategy.)

edit: I can't get the above link to work. One may find the reference by searching for "Martingale betting system" in Wikipedia and scroll to the end of the article.

John
Many wealthy people are little more than janitors of their possessions. | | Frank Lloyd Wright, architect (1867-1959)
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Re: Wiki - Emotions and Investing (new investors - read this

Postby LadyGeek » Tue Jul 23, 2013 8:57 pm

The second paragraph (graf?) seemed to be a run-on sentence. I broke it into two sentences. In the last sentence, I added "any" to read as "get any lower."
In common gambling scenarios, the gambler's fallacy is a belief that a coin somehow knows about, and will try to fix, the fact that a long streak of the same value (such as heads) must end by changing to the other value (tails).

A similar perception can happen when a stock trends in a certain direction. The investor incorrectly detects this as a pattern and guesses it will next go in the opposite direction. The investor has fallen for gambler's fallacy, incorrectly detecting patterns of market behavior and projecting them into the future.

For example, an investor may wish to sell a stock because the price has risen the past 5 days and he thinks it's now "due" for a drop. Or, he might want to hold onto a stock because the price has dropped the past 5 days and he now thinks it can't possibly get any lower.

Third time's the charm? *

*Law of small numbers. :wink:

Check this reference: Daniel Kahneman It contains a brief explanation of prospect theory (the name doesn't mean anything) and a possibly relevant discussion about coin tossing and the law of small numbers. I don't think it changes the explanation of gambler's fallacy here (effects on market).
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Re: Wiki - Emotions and Investing (new investors - read this

Postby Anon1234 » Tue Jul 23, 2013 10:08 pm

livesoft wrote:Has there been any thought on writing up how an investor can take advantage of the emotions and behavioral mistakes of other investors?


There were 2-3 funds by University of Chicago Behavioral Economist Richard Thaler http://www.chicagobooth.edu/faculty/directory/t/richard-h-thaler
All are gone.
http://www.bauer.uh.edu/drude/Fuller-Th ... g.2004.pdf
Thaler doesn't bother to mention these in his CV. Granted the guy has been working nearly 40 years, but still, 2 or 3 failed mutual funds seem like a nasty black eye in the investment management business.
http://faculty.chicagobooth.edu/Richard ... tae/CV.pdf
Swedroe mentioned him a while back in a "who said it?" quiz. Thaler admits he indexes most of his retirement assets.
http://www.cbsnews.com/8301-505123_162- ... ?pageNum=8

Behavioral Growth UBRRX
Behavioral Value UBVLX
Another fund with ticker UBERX. I cannot find the details, the search results are swamped by UBER X, the taxi hailing service. It's possible this fund never existed.
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Re: Wiki - Emotions and Investing (new investors - read this

Postby siamond » Wed Jul 24, 2013 6:11 am

As I was reflecting on what may have driven emotional decisions on my part in the past, there is something I don't quite see captured in any of those behavior categories. Which I'd summarize as "I learn therefore I feel the need to tweak (a tad too much and/or hastily)".

I know this keeps happening to me. I've discovered passive investing relatively recently, I totally endorse the general idea, but there are so many things I am only incrementally starting to understand. And when I get it (or think I do), I feel the urge to act on it. And maybe I'm overreacting or acting hastily.

Check my post on muni-bonds being about asset allocation or asset location... I feel the urge to fix my Excel sheet with all the AA numbers right away! I also realized I have some high-yield bonds and didn't make them explicit as an asset category, and this might be in order to do so. Oh, do I feel the urge to 'get it right' now!

Maybe I should think a bit longer about it, or just let it as is for a while before actually changing things... But then it's not really a change to my general plan, more a "bug" in the implementation, so I'd rather fix it sooner than later... :wink:
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Re: Wiki - Emotions and Investing (new investors - read this

Postby VictoriaF » Wed Jul 24, 2013 7:38 am

siamond wrote:As I was reflecting on what may have driven emotional decisions on my part in the past, there is something I don't quite see captured in any of those behavior categories. Which I'd summarize as "I learn therefore I feel the need to tweak (a tad too much and/or hastily)".

I know this keeps happening to me. I've discovered passive investing relatively recently, I totally endorse the general idea, but there are so many things I am only incrementally starting to understand. And when I get it (or think I do), I feel the urge to act on it. And maybe I'm overreacting or acting hastily.

Check my post on muni-bonds being about asset allocation or asset location... I feel the urge to fix my Excel sheet with all the AA numbers right away! I also realized I have some high-yield bonds and didn't make them explicit as an asset category, and this might be in order to do so. Oh, do I feel the urge to 'get it right' now!

Maybe I should think a bit longer about it, or just let it as is for a while before actually changing things... But then it's not really a change to my general plan, more a "bug" in the implementation, so I'd rather fix it sooner than later... :wink:


Using new information is not a bias by itself. There are some related biases, though. For example, with the status quo bias, one rejects or devalues new information, because he does not want to make any changes. This bias is the opposite of what you are experiencing.

Those who consider various options are sometimes unable to decide. In many cases, too many choices paralyze one's decision making, and even choosing between just two options can create an impasse.

Victoria
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