Emotional Investing

I NSTEAD OF BEI NG SMART, FOCUS ON AVOI DI NG FOOLI SH

BEHAVI OR
Try Counting Backwards from 30
Case 1

82 24 48 86 61 11 What is the pattern in these numbers?
Case 2

A bat and a ball together cost $1.10 in total. The bat costs a dollar more than
the ball. How much does the ball cost?
REFLEXIVE BRAIN

Effortless
Fast
Automatic
Prone To Errors
Also called System 1
Default System go to circuits
Intuitive processing
Example: Smell, Taste , feeling
(Driving a Car) ?

REFLECTIVE BRAIN


Effortful
Reasoned
Slow and Logical
Less Prone to Errors
Also called System 2
Backup Machinery uh-oh circuits
Analytical thinking
Example: Solving 345*235^2
What should I get my wife for our anniversary

What should we use
Reflexive or Reflective ?


Reflexive Gauge the management behavior. (++)
Reflective This is the best quant model built, Ah! It failed only in 2008 (--)
Dose of both are needed
Greed

Thought of finding a multibaggar is super exciting.

Bigger the potential Gain ; greedier you will feel ; you will stop thinking about the odds
Ask what is the chance this stock will earn me the super returns ?

Anticipation is processed reflexively while probability is processed reflectively

Fun Fact Buy the Rumor; Sell the news is based on anticipation

Control Greed see is the stock passes your checklist
If you feel the urge to trade; go play a online poker game

Question What is the expectation when we buy a Stock


Predictions

Over the past thirty years the analysts' estimate of what companies would earn in the next quarter
has been wrong by an average of 41%.

Markets are Random; We look for patterns within this Randomness!

We tend to predict based on shorter term memory and recent events.

Follies with Predictions - Markets have never hit an upper circuit :P Really !!!
I have always made money in this stock

Fun Fact The human compulsion to make predictions about the unpredictable originates in the
dopamine centers ; Dopamine is released, when we have some unexpected profits

Question Should we believe Analysts?

Confidence

Overconfidence makes us take more risks;

Familiar Stocks brings home over confidence [ these can be risky ]

Hurts to say I dont know, hurts our self esteem

Fun Fact
Only 37% of corporate managers believe that mergers create value for the buyers, and a paltry 21% think that mergers meet
the strategic goals set by acquirers. However, when it comes to their own mergers and acquisitions, 58% of experienced
managers say they have created value, and 51% believe they have met their strategic targets.


Question Do you say you know it all? If yes then it means you stop asking questions

Risk

Risk is constantly changing A small change to any one of these can turn you into a bull / bear
Past experiences
Alone or part of a group
How familiar are you with that situation
Your mood

Example
In a small village, there has been a type of flu which has potential to cause death. Population of
village is 600; There are few programs which could help in this crisis.

Set 1
Program A will save 200 people
Program B 1/3 probability of saving 600 people and 2/3 probability that nobody will be saved
Set 2
Program C 400 people will die
Program D - 1/3 probability nobody will die, 2/3 probability that 600 people will die



Risk

Risk can change based on how we frame our questions as well

Positive risk framing Program A will save 200 people
No emotional cost, as we save lives

Negative Risk Framing - Program D - 1/3 probability nobody will die, 2/3 probability that 600 people will die
Here our brain needs to work more, as we see death; we see little chance that people are saved
and emotional side makes us choose D

When we become part of a group (herd) we are inclined to ask less questions

Profit/Loss on your previous investment can also determine how risky the next bet is

Question What creates the frames inside our brains?
Interaction between feeling and thinking; We look for the easiest way to reach to a decision lowest
emotional cost and least mental effort.

Fear

Airplane Crash how risky do you think this is ?

The more vivid and easily imaginable is the risk; scarier it feels.
Emotions shooing away our Analytical Power

When we feel in charge; Risk seems lower than they truly are

Fear of Losing Lasts for Long
We have two or 3 consecutive losses, we will tend to stop betting or even freeze if the impact of
loss was large.

I go along with the herd not because I consciously choose to do so, but because it hurts not to.
Surprise







It's impossible to predict corporate earnings to the penny.
Infosys expectations were not met, stock down. Negative surprise

Unexpected surprises have higher impact.

The future will most brutally surprise those who are the most certain they understand it
Regret

Regret - aftermath of a nasty surprise.
Surprise oh, oops! Moment ; Regret comes after slow thinking, why or how could I

When do we regret
Huge loss - I wish I had not done this or I knew I should have invested in X
Opportunity missed I told you that was going up or I should have sold then

The investments we own tend to seem better to us than those we don't own. Difficulty to Sell ?

Non Fun Fact - Why is it so hard to sell?

"When you sell a loser," explains psychologist Daniel Kahneman, "you don't just take a financial loss; you take a psychological
loss from admitting you made a mistake. You are punishing yourself when you sell." On the other hand,, "Selling a winner is
a form of rewarding yourself.

When we make a large investing mistake, your insula (area of a brain) generates much the same response to your own
action as it would to a pile of rotting fish or a bag of garbage that's been sitting in the sun. You move away from the stench.
(move away from taking Risks)

Question Portfolio Paralysis ?

Regret

Investors are disgusted with their own blunders, their natural aversion to taking a loss finally breaks
Panic Sells

How do we control Regret
Face it and Fess up Ask - Do we have a loss or a lesson?
Profit booking Strategy choose a plan. ( Few have been discussed in the Group )
Get Help from others to help you pull the trigger Banks loan reevaluated by another person
Balance your portfolio asset allocation helps

Checklist

Mcap to Sales < 1

Good ROC > 20

Operations Cash Flow positive for at least 3 out of 5 years

Debt to Equity < 0.5

Will there be growth in sales and profit margins remain stable ( difficult for me )

Technicals see if the trend is up, moving averages 200,50, 20 check


Questions which can control our emotions

Do I understand this company's products or services?

Did I read the company's financial statements, including footnotes?
Reading the AR, can cool you off, if you think the stock is a hot one

Last time, made money on this stock will you make money in the stock again?

Ask these questions when you see prices going down this should cool you off a bit !!

Other than the price, what else has changed?
Are my original reasons to invest still valid?
If I liked this investment enough to buy it at a much higher price, shouldn't I like it even
more now that the price is lower?
What other evidence do I need to evaluate in order to tell whether this is really bad
news?




Some Quotes which I like

The fault, dear Brutus, is not in our stars, but in ourselves
Market is a rapist, only when you dont have our clothes on!


Thank You

Source
Book Your Money & Your Mind Jason Zweig
Prof Bakshi articles.