Anchors A-weigh!

Lost At Sea
In these uncertain times, as the Covid-19 virus moves across the planet, we’re seeing markets yo-yoing with wild price fluctuations on almost a daily basis. Jumps or falls of over 5% are commonplace. This is not normal market behaviour.

However, it isn’t unusual behaviour either – in the context of market history. Anyone who remembers 2008 or 2000 or even 1987 will have seen this before. This is what happens when investors lose their anchors – with nothing to attach to they follow each other, and the result is very predictable and not at all pretty.

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7 Investing Lessons from Behavioral Psychology

Click … bait

You could start by not wasting your time clicking on stupid clickbait articles, I suppose. But since you’re here you might as well learn something.

Investing should be mainly about hard work, slogging through accounts and trying to figure out where or why a company has a defendable competitive advantage. But that’s not much help if you have the self control of an octogenarian with prostate trouble.  Investing is 90% hard work and 10% mental discipline – but don’t even bother if you haven’t got the 10%.

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I Don’t Know What I Like (And I Don’t Know What It’s Worth, Either)

Axiomatic

One of the fundamental axioms of economics is that we know what we like: we have preferences, they're consistent across time and they can be revealed by careful experimentation. This, of course, is utter nonsense. Yet it's not just a guiding principle of economics but is also a rough and ready rule we live our lives by. We make decisions and then we justify them, after the event, because to do otherwise would make a mockery of our choices.

But because we do actually make decisions we must, in a sense, really know what we like, even if we're habitually inconsistent. Unfortunately, outside of our own specialised areas of expertise we don't know how to absolutely value things and all too often we assign a value based on entirely superfluous data intermingled with a bit of relative valuation, reckoning that a Porsche 911 Carrera is worth more than a child's teddy bear. We exhibit coherence but in an arbitrary fashion – a behavior known, rather unoriginally, as coherent arbitrariness.

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A is for Anchoring

Anchoring is a simple psychological bias that causes us to focus on some initial value and then make decisions with reference to it.  For an investor a typical anchor is a purchase price, and you'll often find people won't sell below that price, although that's wrapped up with other biases such as loss aversion.

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The Cherry Coke Effect?

Hunger Games

If you want a favorable decision from a judge pray that you get a hearing early in the day or straight after lunch.  In similar fashion you shouldn’t be making investment decisions on an empty stomach.  In the parlance, such arbiters of justice and seekers after profit are suffering from ego depletion; although we might perhaps just say that they’re hungry.

Anyway, ego depletion seems to have a real effect on our ability to make important decisions: we’re more likely to be decoyed, to procrastinate and to compromise over our decisions when we’re low in energy.  So this explains why Warren Buffett is such a good investor; it must be down to his addiction to Cherry Coke. Surely?

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Your Self-Inflicted 6% Trading Tax

How Not To Make Money

Making a turn from the markets is hard, we all know that.  Unfortunately we tend to make it a lot harder for ourselves than we need to, and if we don’t then the investment industry is always there to lend a helping hand.  For an extortionate fee, of course.

We’ve already looked at the gross amount of money we conspire to lose each year – something in the region of $160 billion a year in the US alone (see: The 160 Billion Dollar Bezzle).  Now a UK writer has looked at what this means for us as individuals.  The answer is, very roughly, a cost of 6% a year.  Which, when the average return from the stockmarket is probably no more than 5%, makes for a not very good way of making money.

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Triumph of the Pessimists

Bad Stuff Happens

Given that markets are pursuing their favourite pastime of bouncing up and down like a manic depressive doing the Hokie Cokie on a Space Hopper, investors might be forgiven for wondering what they should do next. Fortunately the world is full of people offering sage advice. Unfortunately none of it is very useful, at least where 20:20 foresight is concerned.

The underlying lesson is, perhaps, an odd one.  We should invert the normal mindset of the average investor, who's an inveterate, if rather foolish, optimist, and proceed on the basis that something is always about to go badly wrong.   After all, it nearly always is.

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Profit From Self Knowledge

Gnôthi seauton! and is this the prime
And heaven-sprung adage of the olden time!
Say, canst thou make thyself? Learn first that trade;
Haply thou mayst know what thyself had made.

(Samuel Coleridge – Self Knowledge)

Behavioral Moneymaking

It’s easy to talk about the fundamental errors people make in investment but, in truth, we rarely get to see this in action. To judge from the terabytes of trading derring-do published daily you’d be hard pressed to find anyone who actually loses money on the stockmarket. Most people seem to adopt the attitude that, if these behavioral biases make a difference, it’s to other people and never themselves. And often, they believe their own rhetoric.

We can’t usually look inside individuals’ trading histories to point out the mistakes they’ve made, most research is based on gross, anonymised data. However, occasionally some anomaly allows us shed some light on the actual practice of real investors and such an opportunity arose with the trial and conviction of Martha Stewart for obstructing justice in an insider dealing case. Stewart may be a fine host, but she’s no better – or worse – at investing than most of us.

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Financial Memory Syndrome

False Memory Syndrome

There continues to be serious debate over the concept of false memory syndrome, where allegedly innocent people have been accused of serious crimes on the basis of memories which may have little basis in reality. Whatever really lies behind these cases it seems that planting fake memories in people’s brains is rather too easy to make the truth easy to ascertain.

The problem is that our memories are rather more malleable than we’re brought up to believe and it’s easy to create imaginary ones if you know what you’re doing – and often if you don't. Even worse, we can plant fake memories in our own minds and these are implicated in many of the behavioural issues that dog investors. Financial memory syndrome is at the heart of many a financial crisis.

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Putting Down the Credit Cards

Deviant Cards

Credit cards are one of the modern era’s great financial innovations, and have benefited the financial institutions that issue them terrifically. Unfortunately many of the people who use them get rather less rewards, mainly because of the unconscious biases that compel their every conscious move.

One of the few manifest and practical advantages of credit cards, though, is that analysis of their use is a practical primer in many of the behavioural biases which so entrance us on these pages and of the way in which ill-considered legislation magnifies their effects. Credit cards are a marvellous mechanism for a study of our deviant debt-laden ways and the ineptitude of our legislative representatives. However, they’re also the thin end of a very dangerous wedge.

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Anchoring, The Mother of Behavioral Biases

Behavioural Biases (5): Anchoring

Just as an anchored ship rarely strays too far away from its tethering point a human being prefers to stick close to the references with which they feel most comfortable. Anchoring is an easy-to-demonstrate, hard-to-eradicate behavioural bias that has all sorts of nasty implications for investors, many of them not obvious. In fact, along with availability, it has the claim to be the mother of all biases.

The fundamental investment problem lies in the difficulty in deciding what something is intrinsically worth. A skilled negotiator will start from an extreme position, such as a very high price, in order to frame the subsequent discussions. Anywhere and anytime someone presents us with a number in order to start negotiations we’re being anchored. So if it really matters then you need to start from your own number or walk away.

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