10 habits of highly effective investors
Years ago I had the opportunity to co-manage a proprietary trading desk. Our team was an aggressive group of "rocket scientists" and quants. This was in the hey-day of Salomon Brothers and John Merriweather.
On our desk we had one guy who was an absolutely terrible trader. He was wrong virtually 100% of the time. The question would inevitably come up: Why do you keep him? He constantly lost money!
The answer was simple. We kept his risk limit very tight and we did the OPPOSITE of any idea he felt strongly about.
With that contrarian mindset, lets look at the opposite of this article's title and instead ask: "What are the ten things/behaviors to avoid?" (thanks to Barry Ritzholtz for helping with this framework
CONFIRMATION BIAS
Ever find yourself in a situation where no matter what you do, your counterpart will state: “That’s exactly what I thought!” That in a nutshell is confirmation bias. Investors are notorious for looking for validation of their investment thesis. Remember, the markets represent the best minds all looking at the same opportunity. If you think you are unique you are wrong.
OPTIMISM BIAS
Ever find yourself feeling GREAT after a few coffees? That’s the single worst time for you to be engaging in the market. That euphoria will inevitably allow you to feel that you are right.
LOSS AVERSION
Who likes losing? No one. When a trade or position goes against you it is the single WORST feeling to see the color red on your screen. We saw this late last year after Trump was elected. Many folks sold off in that market collapse after his election. Who is sorry now?
SELF SERVING BIAS
Do you own your mistakes? Most folks do not. We hate admitting that we made a mistake or error in judgment. Accordingly, we tend to own the successes and abdicate the loss and failures to others. But, the markets don’t allow for you to survive with this bias. If you cannot admit your failures you will be poorer for it.
THE PLANNING FALLACY
Do you think you can plan for the future? Statistically most people are terrible at this. The term "Black Swan" was introduced in to our lexicon as a consequence of this bias. How many of us thought Trump would be President?
CHOICE PARALYSIS
Too many options result in paralysis, and the markets can provide that choice in abundance. We always taught our portfolio managers to have a short-list of options available at all times for any situation. When the tie comes to make a decision you will not have access to the most valuable resource: time.
HERDING
Are you comfortable being alone in your decisions? Or, heaven forbid…first? Many folks are not comfortable with either. Instead we herd like cattle. When did we see this best? In the Great Financial Crisis. We all thought real estate would continue to rally.
WE LIKE STORIES!
The narrative fallacy is basic human behavior. As investors, we abhor raw data, and instead prefer a story. Stories are what make us human, but very poor investors.
RECENCY BIAS
The past does not equal the future…yet we continue this behavior! We like to extrapolate our success into the future (similar to a US President of late…). The only thing history has taught us is our inability to learn from it.
THE BIAS BLIND SPOT
Despite this article, many folks will ignore it! This bias to not admit that they have a bias is extraordinary, yet quite prevalent. Think you have no biases? Think again.
In conclusion, as an investor I would encourage you to go through this list of 10 biases and ask yourself whether or not any of them played a part in your decision. If they did, think again, and re-assess your investment/trade. You will be glad that you did.