Interesting Stories of Investing Biases

Behavourial Management
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We have heard many times about all these investing aka behavioural biases.

Say Loss aversion / herd mentality / anchoring biases etc etc. We roughly know their meanings and understand many of them. But it’s not easy to APPLY them in our investing thesis.

Here I am trying to understand my mistakes / learnings through these Investing Biases.
These are my mistakes and my personal views.

I am avoiding to take the names of the stocks for obvious reasons, but most people will be able to guess them.

So here is my story.

As it always happens with us retail investors ( mind you, it’s nearly IMPOSSIBLE for us to come up with original ideas ), I came across a stock on social media (SM).

The stock was hitting upper circuits ( UC ) so was in the buzz. Here the Recency Bias kicked in. As we remember recent events better, we think those are important.

With so many people trying to catch this UC stock, the Herd Mentality kicks in. If it’s POPULAR, it HAS to be good.

You try to do the initial study about the business and you find that it’s a small cap so potentially a “multi-bagger” ( We Retailers simply Drool over Multi-Baggers) and it’s in “recycling”. Its “low float” with 73% with promoters. FIIs are buying in. So it fits the “ESG” theme. Now you fall PREY to Confirmation Bias. You only see the positive side of things and simply ignore the negative side.

And now throw in some Authority Bias. One of the main person whom you follow on SM, mentions that stock name ( not his buying price or his allocation percentage). So that stock name just keeps on popping up in your subconscious mind.

Now the FEAR OF MISSING OUT (FOMO) is so strong that you give up and simply jump in. You feel happy that even though the stock was hitting UC, you were able to grab it.
Now after a few UCs , the stock goes on for 2 / 3 consecutive Lower Circuits (LC). So you start worrying. But now the Endowment Bias has set in. You own it,so it’s your precioussss…… So you keep on holding onto your precioussss……, even when the SM Authority person tells you that he has already sold that stock. This ENDOWMENT BIAS makes you think that you are smarter than the market.

So now with 20/30 % loss, you are taken over by the Loss Aversion. You are not willing to book that loss ( as Loss hurts 3 times more than Profit) and keep on telling yourself that it will again hit a few UCs and when it comes to my price, I will sell.

When both Endowment bias and Loss aversion are strong, you fall prey to Sunk Cost Fallacy. And you keep on averaging the stock down. You start putting Good Money after Bad Money. It’s kind of a feedback loop from which it’s not easy to get out.

With time the SM buzz of the stock is gone. Slowly you start realising your mistake and at last you book your loss. And BLAME the market for your loss.

The sequence of such Biases may be different in different stocks, but these biases affect our Rational Thinking in many ways. They work on System 1 and won’t let System 2 come into play.

So how to overcome such Biases?

Well. It’s not easy for sure. But few points I can think of.

Back to BASICS again.

Invest in the business that you understand. COC - Circle Of Competence.

This particular business was out of my COC. And I failed to realise that it’s in the Rubber industry which is a commodity.

It’s difficult to avoid the SM buzzing stocks. But what one can do is - instead of immediately jumping in, keep them on watch-list. Or if you have too much FOMO, buy only a few quantities for the start. Once the FOMO dies APPLY some Checklist for the stock,whichever checklist you prefer.

With such CHECKLIST, you will avoid buying on intuition. It will force you to convert the “Narratives to the Numbers” and Think Rationally. Such a checklist will force you to apply the System 2 and keep in check the System 1.

Hope you liked this story. Please share your opinions.

Also please do share your such interesting stories.
Thanks,
dr.vikas

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Great write up Dr. Vikas. I can fully correlate to this story, almost feels like you spoke of me. Coincidentally I wrote a similar post just a few minutes back summarising the multiple misktakes I committed in the last 1.5 years here. Sameer’s portfolio+tracking: Requesting feedback - #13 by sam11owen.

My next steps are also similar. I plan to concentrate more on my core portfolio and go back to basics. Even if it means some lost time in learning, rather than earning.

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Just Circle Of Competence is Not Enough

In this blog post, I will be sharing my second interesting story on investing biases. The point is - I am trying to be more on the practical side than on the theoretical side of behavioural biases.

Here I am trying to understand my mistakes / learnings through these Investing Biases.

These are my mistakes and my personal views.

So here goes the second story.

As we retail investors rarely come up with our original stock ideas, we keep on searching for them on Social Media. During such a search, I came across a stock.

I watched an API webinar on YouTube. The person presenting it had given the full disclosure beforehand. In his talk, I heard about a small cap pharma company. He explained how the company has improved its ROCE in recent quarters , how one large US Pharma company has given business to them, and it’s even exporting to China etc. So here I fell prey to AUTHORITY BIAS. Mind you the speaker has not at all talked about his entry price / his allocation.

So now I start following the stock. And to my surprise, it slowly rose from 200, 225,250,275 to 300 levels in just a few months. So now the Fear Of Missing Out (FOMO) sets in. How can I let this future MULTIBAGGER ( being a small-cap ) go out of my hand? So I end up buying it above 300.

And as happens with many of us, as soon as we buy the stock, it starts falling down. I try to find the reasons but find none on SM.
Now as I own it, it becomes my PRECIOUSSS…. So the ENDOWMENT BIAS kicks in.

And this time I had my reasons to hold on to it. Being a medical professional, it’s within my Circle Of Competence (COC). The company manufactures APIs for different types of antibiotics and many chronic therapy molecules. Company is exporting across various geographies. So lots of “Optionalities”. On the corporate front, the company has announced a dividend after 20 years, So it’s a TURN-AROUND candidate. This CONFIRMATION BIAS blinds me from studying the company any further.

But now stock starts correcting from 300 to slowly 250. Now the LOSS AVERSION kicks in. As the pain of loss is 3 times more than that of profit, I don’t sell it. And with CONFIRMATION BIAS so strong, I end up averaging it down all the way till 180. This is classical SUNK COST FALLACY - Throwing Good Money after Bad Money.

Now the company declares its Q2FY23 results. Mind you the results are not that bad, but the market hammers down the stock to 140 levels. Now I don’t have the DARING to either average it down or even to hold it. And at last I sell it at a huge loss. And BLAME the market for my loss.

So the Learnings - Just because the business is in your COC, one simply can’t buy it blindly. You still need to study it thoroughly & apply some check-lists before buying it. Particularly in this company, there were irregular Investor Presentations & no conference calls.

Another important point is - Avoid Averaging Down and Apply some Stop-Loss- (maybe price related / time related) especially in these borrowed conviction ideas. This can definitely help in avoiding biases like Loss Aversion & Sunk Cost Fallacy.
Hope you liked the second story also. Please share your opinions.
Also do share your such interesting stories.
Thanks,
dr.vikas

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Please read these simple factors which can help in long way

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A nice article written by Vishal Khandelwal:

35 Ideas from 2022 - Safal Niveshak

9. It’s Never a Market Crash Problem

It’s almost always an –

  • I don’t know who I am problem
  • I don’t know how much pain I am willing to take problem
  • I don’t have the patience to give my stocks time to grow problem
  • I bought on the tip of that popular social media influencer and did not do my homework problem
  • I did not diversify well problem
  • I bought the stock just because it dipped problem
  • I cannot resist my friends getting rich problem
  • I love to fall in love with my stocks problem
  • I cannot differentiate between stock price and intrinsic value problem
  • I suffer from a buy at any price problem
  • I borrowed to invest problem
  • I invested the money I needed soon problem
  • I don’t have time on my hands to see through market cycles problem
  • I trade too much and too often problem
  • I keep watching and worrying about stock prices problem
  • I will watch the market and my portfolio again after reading this post problem

And so, I must remind myself this at all times –

A market crash is ‘never’ the problem. ‘I’ am the problem, and I must sort myself out, because that is only what I control. And if I can control the ‘I’ better, a market crash will never be a problem.

PS: Reminded me of the stories shared on this post, hence adding here. Please delete if not relevant.

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Borrowed Conviction can be injurious to your Financial Health.

Hope you guys liked my previous two investing stories.

Now let me narrate my third one explaining how Borrowed Conviction ( BC ) can be dangerous. The point is - I am trying to be more on the practical side than on the theoretical side of behavioural biases. This way it will be easier to understand them and AVOID them if possible!

These are my experiences , mistakes and my personal views.

So the third story.

Along with Equity, Debt & Gold, the next asset class is Real Estate(RE). And it’s the FANCY of Indians just like Gold. But the major problem with Real Estate is the HUGE initial investment.

Means you can’t build it in the form of SIP in a Mutual Fund or even as instalments in a Recurring Deposit. RE has to be purchased in BULK at the start itself. Another option is partnering with your relatives / friends. But again others may not agree at the time of selling it. So it’s an illiquid asset.

But I had the ‘itch’ to own some kind of RE of my own. So what are the options?

Real Estate Investment Trusts (REIT) OR shares of listed RE Players.

For REITs, the capital appreciation may be somewhere around 10-12% and a dividend yield of around 3-5 %. So overall 13-15% returns. But we retailers are GREEDY and want to get rich quickly. So we demand more than 20- 25% returns. So I started looking for listed RE players.

While searching the SM, I came across a webinar on RE players. Going through that webinar, I stumbled upon a stock ( Mind you - The Presenter had clearly stated that he has not invested in it) which has a huge land bank- both commercial & residential ,but trading at significant discount due to huge debt & a possible corporate governance issue. But recently a reputed RE Developer group had bought a significant stake in it. And even one of the biggest International Investment firms had investments in it.

So “Market is Fool” for not valuing it “efficiently" and here is the SPECIAL SITUATION / A TURNAROUND story. We Retailers simply ‘drool’ over such words. This is the EASY WAY to make money.

So I jumped in & bought the share around 180. And as it happens often, the stock starts correcting slowly and steadily.

But now the stock has become my PRECIOUSSS…. So I hold onto it due to the ENDOWMENT BIAS. And as the pain of loss is 3 times more than that of profit, I refuse to sell it. So I succumb to LOSS AVERSION.

When I started searching the SM again to find the reasons for the fall, I came across 2 /3 such people ( whom I follow closely) who are also holding it and are regularly posting about it. So now I come under the influence of AUTHORITY BIAS.

This authority bias leads to CONFIRMATION BIAS. This confirmation bias converted my loss aversion into the SUNK COST FALLACY and I kept on averaging down the stock all the way till 80.

Though I did study the quarterly results of the company, I still avoided selling it not only because of all the above biases but also as the company was outside my circle of competence. So I was not able to analyse the results properly.

And I, along with all others, are still waiting for the pending NCLT result.

But at last, I threw in the towel and sold the stock with overall more than 50% loss a few months back.

So the lessons learnt.

Basic is to avoid investing outside your circle of competence (COC). The problem is once you buy such a stock, you have to rely on Borrowed Conviction. Once you fall prey to BC, you come under the Authority Bias. You have to blindly follow such authorities. But we can’t know their exact entry price and their allocation percentage. And more importantly we can’t borrow their OWN CONVICTION.

If you have done the study & investing with your OWN CONVICTION, you have the COURAGE & PATIENCE to hold on to that stock even if it falls 70-80% ( which is a norm if you follow the history of Multi-Baggers)

But when you buy on BC, even a fall of 10 - 20% will give you sleepless nights. And the worst part being, you will fall prey to such a chain of Investing Biases.

So avoid investing on BC. If you find some stock idea very fascinating, take some initial tiny allocation to avoid the FOMO and apply some check-list , study the idea further and then only decide about increasing your allocation in it or exiting even if at a small loss.

Hope you found this story interesting and was able to correlate the interplay of these Investing Biases.

dr.vikas

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So after the 3 interesting stories, let’s delve slightly deeper in the individual biases. Don’t worry. I won’t bore you with definitions or some heavy jargon or some theoretical stuff. It will be something more practical with few examples. Also it will be only related to Investing. I will be discussing one BIAS every blog in no particular order.

So let’s start.

The first bias is going to be ANCHORING BIAS.

What is Anchoring Bias ?


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As the name suggests itself, you are anchored to something. And it’s difficult to let go.

Wikipedia definition is - The anchoring effect is a cognitive bias whereby an individual’s decisions are influenced by a particular reference point or ‘anchor’.

This can come in various forms. Maybe you are anchored to the security price itself or say to a ratio like PE / ROCE / OPM etc.

The most obvious one is the anchoring to the security price. And this can happen for both buying / selling.

From my example, in 2007/08 , I was following CRISIL. At that time, due to the Global Financial Crisis, when most of the stocks fell, this also came down to 2200 levels. But I was anchored to the round figure of 2000, so I didn’t buy it and missed it. My anchoring bias was so strong that I never looked to buy it again. And from there it has become a 10 bagger in the last 14 years. So for saving a mere 10%, I missed 1000% gain.

It recently happened with Hikal when it fell down from 500 to 250 due to environmental mishap. But I was adamant to buy below 200. But again missed it, but some or what got the courage to buy it over 300.

Another instance where I was LUCKILY able to overcome anchoring bias was the Mold-Tech pack. I bought it at around 300 ,but again sold it at 400 for some reason. But after studying the business, bought at 500. And since then I have been riding the journey.

Same can happen with say anchored to some PE or Price/ sales or PB ratio - above which I won’t buy.

Or say below one particular ROCE / OPM ratio , I won’t touch it.

Ex. Titan / D-mart.

In both Titan and Avenue supermart, I avoided investing in them due to their high PE and single digit NPM. But both (even being index stocks) have become 2 baggers in less than 3 years.

So that way my anchoring to high PE & single digit NPM was wrong.

The anchoring bias can be with industries also. It’s well known to invest in companies that are in your circle of competence. But this itself can be a part of anchoring bias. So one can be more CURIOUS and give more time and study other industries also to overcome this industry anchoring bias.

For me, being in the medical profession, I am kind of anchored to the whole Healthcare sector, be it pharma / hospitals / diagnostics. So naturally the healthcare sector is overweight in my portfolio. But what if it doesn’t perform for a few years, I won’t be able to beat the index. And more importantly do I have the courage to sit on with for a LONG TIME?

So how to avoid anchoring bias?

1. Acknowledge the bias

Being aware of your bias is the first step. Know the weaknesses of your mind and anticipate prejudiced judgment.

2. Drop your own anchor

The next time you impulsively pick up a stock , try to talk to yourself.

  • What is its intrinsic value? Is it a bargain?
  • Apply some checklist to know if it fits your investment criteria
  • Does this stock offer BETTER value than the stocks that you already hold in your portfolio?

3. Try to reflect on when the anchoring bias last affected your decisions

Here the importance of keeping the “Investment Diary " comes in.
Try to write a small note on the company in simple words that even a 10 year old can understand.

  • Why are you buying this ?
  • What is your time Horizon?
  • Under what circumstances will you sell it?

This way you will be able to realize your biases better and try to prevent them.

Actually all these biases are like the System 1 mentioned by Daniel Kahneman and by doing the above exercises you can try to use the System 2 to overcome these investing biases.

Thank you for reading Vikas’s Substack. This post is public so feel free to share it.

Hope you liked this piece on the anchoring bias.

I Will cover the ACTION BIAS in the coming blog post.

Please feel free to like, comment & share.

Regards,

dr.vikas

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So after covering the ANCHORING BIAS in the last blog, we will be discussing the ACTION BIAS today.

As always this will be more on the practical side than on the theoretical side and related to investing.

As the name - ACTION suggests, we humans tend to do something or other to keep ourselves busy.

We human beings are in a constant state of action. We think ACTION = LIFE. Well, that is true as far as the definition of living beings go. But TOO MUCH of anything can be detrimental.

Now here is the one perfect example of Action Bias.

‘ In soccer penalty kicks, goalkeepers choose their action before they can clearly observe the kick direction. An analysis of 286 penalty kicks in top leagues and championships worldwide shows that given the probability distribution of kick direction, the optimal strategy for goalkeepers is to stay in the goal’s centre. Goalkeepers almost always (i.e., in 93.7% of the kicks) jump to the right (44.4%) or left (49.3%) instead of staying in the centre.

The reason for this obviously non-optimal behaviour by goalkeepers was an "action bias ".

In simple words, Goalkeeper will look like a fool if he stays in the centre rather than diving on either side.

Below is the link for the study.

In investing, this is very well captured in a Warren Buffet quote -

'The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, “Swing, you bum!” ’

We Indians LOVE Cricket. Here I can think of a perfect example of not falling prey to ACTION BIAS is The Wall - Rahul Dravid

He had the immense PATIENCE to let go of all the dangerous off-side balls. This frustrated the bowler who invariably used to start bowling on different line & length and then Dravid used to be on the top of that bowler.

Similarly in investing, here is what Charlie Munger says -

And our excessive activity aka Action bias can lead to other biases also. Few Examples.

When you fall prey to the latest SM frenzy , the FOMO sets in and this action bias pushes you to buy into the overheated stocks.

And the “ITCH” for further action will force you to either apply STOP-LOSSES or worse do the averaging down / coming out of the great business for a meagre 10 /20% profit.

In my personal experiences, I have fallen prey to action biases so many times that I have simply lost the count. Today’s digital age makes it very difficult to stay away from the SM noise and so from Action Bias.

The solution again is not easy as always.

But few things can be considered.

1 - Sleep Over that idea.

Whenever you come across a new stock idea, take some time , apply some check-lists and then only buy it. This will avoid the FOMO & the subsequent Action Bias.

2 - Avoid Social Media Noise

Be very selective in what you read on SM. Pick only useful groups on Whats app & Telegram. Follow a few selected Twitter Handles. Read selected websites and research reports only. The less the SM Noise , the less will be ACTION BIAS.

3 - Avoid watching your portfolio too frequently.

This is easier said than done. But this is so obvious. The more we see our portfolio, the more we will get the ‘ITCH’ to do something.

“Looking at your portfolio frequently can make you feel like it’s performing worse than it actually is, and the less likely you’ll invest correctly for long-term success,” Egan says. Excessive monitoring of short-term returns can lead to knee-jerk reactions and impulsive decision-making that doesn’t lend itself to letting your money grow over time.

One simple trick that I do myself ( sometimes, not always) is to simply buy a few quantities of say stocks of core portfolio companies / some ETF units on Monday Morning itself. This can reduce the ACTION BIAS in the subsequent weekdays.

That’s all for ACTION BIAS.

Hope you people liked it.

dr.vikas

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So after covering Action Bias in the last post, we will discuss RECENCY BIAS in this post.

So what’s a Recency Bias?

As per Wikipedia - Recency bias is a cognitive bias that favours recent events over historic ones; a memory bias. Recency bias gives “greater importance to the most recent event”

The recency effect describes our tendency to better remember information that was most recently told to us. It is believed that the recency effect occurs because those items are stored in our short-term memory, which is only able to hold a small amount of information at a time. It stores the information that was most recently told to us allowing us to access it during recall quickly.

One real-life example ( not related to investing ) that I remember was - When famous Indian actress Sridevi died, there was a poll conducted on social media asking who was the all-time great actress. Due to the recency bias, most came up with Sridevi’s name.

On the same note, if I carry a poll of the worst performing Indian batsman now - the most probable answer will be K L Rahul as he has a poor track record in the recent past. And if you had surveyed for the best batsman in the world after the recent nail-biting India-Pakistan T-20 match at Melbourne, the obvious answer should have been Virat Kohli.

When it comes to investing, recency bias often manifests in terms of direction or momentum. It convinces us that a rising market or individual stock will continue to appreciate, or that a declining market or stock is likely to keep falling. This bias often leads us to make emotionally charged choices—decisions that could erode our earning potential by tempting us to hold a stock for too long or pull out too soon.

A few more examples that I can think of are

  • Stocks in continuous upper / lower circuits - Retail investors in the greed of making QUICK money, fall prey to penny stocks. These are typically manipulated by operators. When small investors see these stocks going up daily in upper circuits, they fall prey to RECENCY BIAS and hence the FOMO and then ACTION BIAS - they end up buying them. And the same thing repeats on the way down and retailers lose their hard-earned money. The same can be said for the BUZZING stocks in Social Media. They induce the Recency Bias and then FOMO & Action Bias.

  • Recent Cryptomania - During the COVID times, due to liquidity, there was a bubble in all the Cryptocurrencies and when common people saw all these cryptos just going up daily, they assume that investing in them was the sure shot way to getting RICH QUICKLY. So many people ended up buying them due to FOMO and then lost BIG when liquidity was sucked out of the system.

  • COVID Gloom & Doom - During the peak of covid pandemic, people were so scared that if you should have asked about the possible deaths due to covid, the majority of them should have come up with some figures even higher than combined World War I & II deaths.

  • Mutual Fund Performance - This is again a classical example of recency bias. When choosing the MF to invest in, people tend to look at the RECENT performance say last quarter / last year. So if the fund has not performed well recently, we think it’s bad and we avoid it. And the other way, if the recent performance is good, due to the recency bias we tend to invest in it.

We, retailers, check our portfolio performance very frequently even every few minutes. This can be so detrimental. Because, when we see our stocks in red every few minutes, the RECENCY BIAS can kick in which may lead to ACTION BIAS. So we may either end up selling that stock or may average it down to avoid the LOSS AVERSION.

So the point is - all these behavioral biases are interlinked.

Ok. So what’s the solution ?!

For avoiding the Recency Bias, the solutions are the same as those for Action Bias.

1 - Avoid the SM chatter

Be very selective in what you read on SM. Pick only useful groups on WhatsApp & Telegram. Follow a few selected Twitter Handles. Read selected websites and research reports only. The less the SM Noise, the less Recency Bias will be.

2 - Sleep Over that idea.

Whenever you come across a new stock idea, take some time, apply some checklists, and then only buy it. This will avoid Recency Bias, the FOMO & the subsequent Action Bias.

3 - Maintain your own Investment Diary.

The more I am thinking and write about all these Biases, the more I am realizing the importance of writing an investment journal. Be it physical or digital. It will force you to write your Investing Thesis & Anti-Thesis about the stock. Also, write in which circumstances will you sell the stock even before buying it. This will help immensely by avoiding many behavioural biases.

That’s all on the Recency Bias. Hope you liked it.

Please like and subscribe. Also, suggest which Bias you want me to cover for the next blog post.

Thanks,

dr.vikas

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Brilliantly written Vikas …

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Thanks a lot for appreciating my efforts

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Brilliantly written, especially taking the practical aspects of the cognitive biases and applying into investing aspect.

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Thanks a lot, Sachin.

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