A year ago I read a book on behavioral finance and today picked it up again to read through the highlights.  It’s a fascinating subject that can make any trader a better trader if they can learn about themselves and their ability to be more mechanical, less emotional with trading.  I figured I would post a thread and see if anyone wanted to share any thoughts on the subject.  Perfect example would be today.  The last two days the markets put in some pretty bullish action, each day moving down and then rallying at the high of day and in fact yesterday was a new high.  Then you get a big down day today with a little recovery into the close and the fear begins to set in.  One highlight in the book is the reality that a loss is 2.5 times more difficult emotionally than is the joy of winning.  Perhaps that is why down days seem to garner a lot more emotion than up days.

As traders and investors we need to understand if this fear is our own emotion guiding us or if it’s based on something more fundamental. 

Anyway, hoping we can get a little discussion started here.

Thanks in advance for sharing your experience, what you’ve learned about your own investing and emotions, etc.

Tony

Tony, I am temporarily away from my library.  In it are a couple of references I will share when I am again in position to peruse the shelves.  Meanwhile there was a short piece in the WSJ Thursday by Jason Zweig on the subject of How to Ignore the Yes-Man in Your Head.

[...]your own mind acts like a compulsive yes-man who echoes whatever you want to believe. Psychologists call this mental gremlin the “confirmation bias.” A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs.[...]

100 guys with $10,000 each is given five minutes to decide whether to press the red button or not.  For each red button pressed, $200 would be deducted from each guy.  You would only lose half of what would be lost if you press the red button.

During the financial crisis, everybody press the red button.  If nobody have pressed the red button, each would have left the game with $10,000.  Since everybody panic and press the red button, each have to make do with $5,000.

I posted this on another thread - very interesting and worth a post here -

A study took two groups and asked them to flip a coin and record each result (heads or tails).

Group 1 was given a physical coin and often would see a run of 15 heads in a row before seeing a tails.

Group 2 was not given a physical coin but rather asked to imagine the result and their runs of heads would never exceed 4 or 5.

The conclusion was the concept of gamblers fallacy where the odds of a flipping a coin each time regardless of past results are always 50/50.  Yet the more the coin flips to heads for example the more we begin to anticipate that heads “can’t happen again.”  As traders we need to learn to not anticipate the market but rather let the market tell us the direction.

capablanca - 22 November 2009 01:51 AM

Tony, I am temporarily away from my library.  In it are a couple of references I will share when I am again in position to peruse the shelves.  Meanwhile there was a short piece in the WSJ Thursday by Jason Zweig on the subject of How to Ignore the Yes-Man in Your Head.

[...]your own mind acts like a compulsive yes-man who echoes whatever you want to believe. Psychologists call this mental gremlin the “confirmation bias.” A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs.[...]

Thanks for sharing this article - I just read it.  One thing I have done differently the past few months versus a year ago is not take a stand as bullish or bearish.  I try to be more neutral in the market always having some sort of long and short position.  For example I have been doing more buy writes taking small common positions and writing calls against them so that way I can play both directions (I’m too wimpy to short and hold overnight so writing calls or buying puts are my shorts).  I’ve been rereading Jesse Livermore’s book and he talks often about going to cash for the simple reason of it allowed him a better chance to form a non-biased opinion of the markets.  The one thing I really need to learn though is taking positions (long or short) when the market confirms or at least gives strong indications that is the direction.  I’m still in the mindset of trying to time tops or bottoms (I know that will kill a man so I am working on that). 

I can say the past few months I enjoy trading a lot more.  I don’t wake up in the morning praying for the markets to be up or down but rather telling myself I will work with whatever market the day presents.  I have a long way to go but feel I’m getting less emotional and more mechanical.  aapl is a perfect example for me, I still have a decent position but have scaled back my euphoria about hitting that home run overnight.  I’d rather pick up singles and keep on playing.