Winning or losing, staying in the game is the thing for some investors
Traders could be uncomfortable with winning or get a lot of excitement from losing
Business Day – 24 AUGUST 2020 – MICHEL PIREU
Why do we buy the stocks we do? According to Terrance Odean, professor of finance at the Haas School of Business at the University of California, individual investors mostly buy those stocks that catch their attention, that have experienced extreme price moves or that are in the news.
The reason is that we have a huge search problem when it comes to finding an individual stock to buy; we’re not equipped to deal with the hundreds of options that are available to us daily and most of us solve this, unconsciously, by only considering those stocks that catch our attention.
“Suppose there are a dozen attention-grabbing stocks one day,” says Odean. “A momentum investor will buy the one that appears to be on a roll. A value investor or a contrarian will be drawn to the one that’s fallen out of favour, but both will most likely limit their choices to one of the 12 stocks.”
Why do we buy stocks at all? Passive investing is boring, but it makes a lot of sense. It’s low cost and saves you the bother of trying to beat the markets. But what if making money isn’t what you’re really after?
The default assumption is that we trade the markets to make money, that it’s a game we all want to win. But as Ed Seykota points out in Market Wizards, that’s not always the case. He tells the story of a trader friend who consistently loses all he makes.
“He just can’t help himself,” says Seykota. “I don’t think he can do it any differently. He wouldn’t want to. He gets a lot of excitement, he gets to be a martyr, he gets sympathy from his friends, and he gets to be the centre of attention. Also, possibly, he may be more comfortable relating to people if he is on their financial plane. On some level, I think he is really getting what he wants.”
“I don’t care whether they’re big investors or little investors,” wrote Adam Smith in The Money Game. “If they make a little money, they’re happy, if they lose a little money, they’re not too unhappy. What they want to do is call you up. They want to say, ‘How’s my stock? Is it up? Is it down? What about the earnings? What about that merger? What’s going on?’
“And they want to do this every day; they want a friend, they want someone on the telephone, they want to be part of what’s going on, and if you gave them a choice between making money, guaranteed, or staying in the game, and if you put it in some face-saving form, every last one of them would pick staying in the game. It doesn’t make sense, or the kind of sense you expect, but it makes a nutty kind of sense if you see it for the way it is.”
As long as you keep playing, it is because you’re getting what you want out of the game. So you need to ask yourself: are you uncomfortable winning? Do you enjoy a lot of excitement? Would you prefer to have an interesting story to a boring but winning trade? Do you find it hard to go your own way, as opposed to following the herd and the news? If you have any psychological flaws — and yes, we all have them — the markets will draw them out and exploit them. That applies to your behavioural biases too.
“You can read all the books you want,” says Ben Carlson at A Wealth of Common Sense, “but it’s not going to help you in the moment. You can’t suppress your natural instincts.”
You might feel confident, logical and a good decision-maker, but unfortunately this may just be part of a story you’ve developed about who you are, why you do what you do, and why you think what you think. It’s undoubtedly a good story, and you believe it day to day, but it may be fiction. Yes, we are capable of logic and reason and rationality, but when we fall short of those ideals we tend not to notice. We have a tendency to create a narrative in which we see ourselves as the sort of person we want to be, rather than who we really are.
If success in trading could be achieved by doing what comes naturally, the only prerequisite for success would be sufficient capital. Since that is clearly not the case, native instinct must somehow mislead. And indeed it does. Every trading error is the result of doing what comes naturally: taking profits too quickly, holding losers too long, averaging down, acting on a rumour, loading up on a sure thing. These are the things that come naturally.
“Everybody hopes to have a windfall in the financial markets,” says Bent Flyvbjerg at Saïd Business School, “especially the novice investors, who still think they’re going to be better than the average. The hardest thing to learn is not to be too optimistic. It’s really difficult. It takes a lot of time, and a lot of experience, and there are very few out there who have this cool realism.”