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15 Mistakes to Avoid to Make a Killing in the Markets1 |
15 Mistakes to Avoid to Make a Killing in the
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| 215 Mistakes to Avoid to Make a Killing in the Markets
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15 mistakes-to-avoid

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  2. 2. 15 Mistakes to Avoid to Make a Killing in the Markets1 | 15 Mistakes to Avoid to Make a Killing in the Markets Dear Reader, Investing is as much about trying to keep one's head when everyone around is losing theirs, as it is about getting first rate information and performing cutting edge analysis. It is as much about being fearful when others are greedy and greedy when others are fearful, as it is about accessing quarterly results and applying complex research model. And it is as much about buying only when the stock is available at a margin of safety as it is about putting a company's historical statements on an excel sheet and performing sophisticated valuation. What I’m trying to say here, is that when it comes to stock market success an individual’s behaviour is as important, if not more, than research and analysis. If you are reading this guide, you must be wondering whether you also make behavioural mistakes. And in fact there are some common mistakes most investors tend to make throughout the investing process - ie, when picking, buying, holding and selling stocks. As you take stock of the successes, pitfalls, and mistakes you make in your investing history, you will probably find – like most everyone else – that those mistakes were made because of your own behaviours. Most mistakes investors make are due to their own biases which keep them from making rational decisions. These biases are psychological - they are basically 'hard wired' into us as humans, and in many cases are very helpful in making decisions. In investing however, they often lead us to poor decisions and loss of returns.
  3. 3. | 215 Mistakes to Avoid to Make a Killing in the Markets If you take the time today to become aware of the mistakes you might have made in the past, correct the biases you may carry, and go forwards with greater understanding and better investing decisions, I believe you will find much greater investing wealth in your future. Below are some of these biases, how they work, and most importantly, how you can avoid them. 1. Anchoring Bias: Most people are over reliant on the first piece of information they come across. For example, paying Rs 1,000 for jeans with a 50% discount on a rack rate of Rs 2,000 may look like a steal, even when it might be available for still 20% lower at a store next door. Most often, in stock investing, anchoring bias is based on past stock price. For instance, you may not want to buy a stock at Rs 100 if you know it has traded at Rs 80 last week... Even if the real value of the stock is Rs 200...and the stock may never correct back to Rs 80. To overcome this bias - forget about past price, and always think only about the current valuation of the stock. 2. Choice-Supportive Bias: When you choose something, you have a natural affinity towards it and tend to feel positive about it, even when it has its flaws. For example, you still believe your own dog is the best - even if it bites people every once in a while. This leads to 'marrying a stock', that is holding on to your choice despite all the fundamental negatives, and ignoring newer information. To overcome this bias, think about your stocks as though you are investing in them for the first time - with 'fresh eyes'. Ask yourself, would you choose to buy the same stock today?
  4. 4. 15 Mistakes to Avoid to Make a Killing in the Markets3 | 3. Ostrich Effect: The ostrich effect takes the choice bias further. It is to ignore dangerous or negative information by 'burying' one's head in the sand, like an ostrich. While you don't have to keep checking on how your stocks are doing every single day, choosing to ignore vital information about the business can prove disastrous. So, make sure to stay updated on the big moves the businesses you have invested in are making, what it means for them, and then make a decision whether you will act or not. 4. Bandwagon Effect: The bandwagon effect is essentially groupthink, i.e. blindly following what others are doing because it seems to be working for them. The probability of one person adopting a belief increases based on the number of people who hold that belief. Is your conviction about a particular stock higher when your broker, your neighbour, your best friend, and everyone you know, is buying it? That's the bandwagon effect in play. Sure, you don't have to be a contrarian about every single decision you take, but following the herd without doing your own research, will lead you to holding falling knife rather than anything else. 5. Complexity Bias: Simply put, it is the belief that complex solutions are better than simple ones, or to say complex businesses are better than simpler ones. While
  5. 5. | 415 Mistakes to Avoid to Make a Killing in the Markets complex businesses have a lot going for them, it does not necessarily make them better than simpler ones. In fact, great investors really focus on 'simple' businesses which they understand. Warren Buffet calls it his 'circle of competence' and has been quite disciplined in staying within it. Your 'circle of competence' would comprise all the businesses that you are familiar with and thoroughly understand. 6. Confirmation Bias: We tend to pay attention only to information that confirms our preconceived notions. Once we have a notion in our head, we tend to selectively look for evidence supporting the notion. As they say, first impressions are the most lasting. Confirmation bias causes no harm if the initial notion or impression is correct. However, if it is wrong, the bias prevents us from realising our error quickly. One way to avoid being suckered into confirmation bias is to constantly question yourself, and play devil's advocate to try and look for conflicting evidence. 7. Recency Bias: This is the tendency to weigh-in the latest information more heavily than older data. If you look at a stock, which has been going down for a few days, you tend to believe that the particular stock is not a good one. However, only when you look at the long-term trend, you realise that this is but a mere blip in the stock's life. The opposite holds true as well. You see a stock outperforming, only to realise the rally was short-lived and unsustainable. Recency bias can make you miss out on good stocks, or lead to losses by jumping on to unsustainable ideas. 8. Survivorship Bias: This is the tendency to only look at data that has 'survived' or excelled, while ignoring anything that didn't make it. Survivorship bias can lead to overly optimistic beliefs because the failures are ignored. For example, if taking a particular course of action worked for a business, we tend to believe that it was the right thing to do, without considering the fact that many other businesses did the exact same thing - but failed. To avoid this bias, best not to just dwell on past results and performance and look at businesses more objectively.
  6. 6. 15 Mistakes to Avoid to Make a Killing in the Markets5 | 9. Information Bias: This is when one tends to seek all kinds of information that doesn't really affect action. That is to say, even with enough information, one wastes time trying to collect more information, even if that has no use in the situation. More information is not always better. The key to successful investing is to separate the wheat from the chaff and filter out unnecessary information, which at best will waste your time, and at worst will distort your judgement. 10. Outcome Bias: Judging your decision based on the outcome, rather than how the decision was made, reeks of outcome bias. Sure, you made a good return on a stock tip from your broker. But does this mean, tips are a viable method for good returns? What happens when they don't work? Focus on how you came to a decision to buy/sell a stock, rather than the outcome of it. It will not only help you avoid the same mistake, but also help fine tune your process. 11. Clustering Illusions: This is when you start seeing patterns in random events. The belief that the market will go up after four straight days in red, is a classic example. View your investing philosophy as separate from events in the market. The stock market has a mind of its own, and its movements are more or less random. Trying to predict market movements will only end in pain. 12. Availability Bias: This happens when you overvalue the information that you possess. It may well be the case that the information you are using to base your judgement of is incorrect, or incomplete. Availability bias makes you think that the examples that come to your mind are more representative than is actually the case.
  7. 7. | 615 Mistakes to Avoid to Make a Killing in the Markets For example, if you just got a new job you are more likely to believe the economy is flourishing and the job market is great. However, someone who just got laid off might not share your views about the same economy and job market. A way to avoid availability bias is alter your focus on the long term and be sure to weigh in other perspectives before jumping to a decision. 13. Incentive Bias: One of the most important consequences of incentives is what Charlie Munger calls 'incentive-caused bias'. The following example will best explain incentive bias. Early in the history of Xerox, Joseph Wilson, who was then in the government, had to go back to Xerox because he couldn't understand why its new machine was selling so poorly in relation to its older and inferior machine. When he got back to Xerox, he found out that the commission arrangement with the salesmen happened to give a large incentive to push the inferior machine on customers. An incentive-caused bias can tempt people into immoral behaviour, like the salesmen at Xerox who harmed customers in order to maximize their sales commissions. The story of mutual funds in India is similar to that of Xerox. Mutual funds that offer the maximum commission to distributors are the best sold funds. Also, consider your own stockbrokers. There will seldom be one who will not lure you to trade too often. Understand the motives and incentives of people and organisations you're dealing and investing with. Everyone ranging from the company you're investing in to
  8. 8. 15 Mistakes to Avoid to Make a Killing in the Markets7 | your stockbroker, your mutual fund agent and your equity advisor, your source of information (yes, even I) must pass your scrutiny. 14. Conservatism Bias: This is when one tends to hold on to old investing views or forecasts at the expense of acknowledging newer information. For example, if an investor believes a certain forecast of a company's sales to be true, but soon after he receives newer information that one of the company's plant had to be shut down, he may under-react to the news because of his original impression rather than acting on updated information. To steer clear of conservatism bias, be open to new information and change or amend your actions accordingly. 15. Blind Spot Bias: If you made it through the list without identifying with any of the biases, this one is for you. Failing to recognize your own biases is a bias in itself. This puts you in a blind spot, where it becomes difficult to understand reasons for failure without some introspection first. People tend to notice cognitive biases in others, more than they do in themselves. To take control of your investing process, take a step back and understand the biases that are holding you back. Understanding you own biases and taking control of them can help you become a better investor. And when it actually comes to picking stocks, you always have my recommendations for that - check out my list of 4 small cap stocks that are set to profit from the market crash in the rebound.
  9. 9. | 815 Mistakes to Avoid to Make a Killing in the Markets © Equitymaster Agora Research Private Limited. All rights reserved. All rights reserved. Any act of copying, reproducing or distributing this Guide whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute personalized advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results. SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537. Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India. Telephone: +91-22-6143 4055. Fax: +91-22-2202 8550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407 Cover Page Image Source: bluebay2014 / www.istockphoto.com wildpixel / www.istockphoto.com “I See This As the Biggest Wealth Creating Opportunity of 2019” – Richa Agarwal Richa’s been priming her readers for it… The last time this happened, the Sensex doubled in close to a year… Stocks multiplied by double and triple digits… Here’s why Richa thinks the biggest wealth creating opportunity in a decade is set to repeat itself… Click here for full details.

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