Five common pitfalls to avoid


Michael J. Mauboussin offers great advice to avoid the dreaded market despair:

Knowing yourself means understanding how you’re likely to behave under various circumstances. Over the past couple of decades, behavioral finance researchers have developed a clearer understanding of the psychological traps investors fall in. The best way for you to avoid these traps is to become aware of them, the forms they take, and which you are most likely to fall into.
Here are five common pitfalls:
1. Over-confidence. Researchers have found that people consistently overrate their abilities, knowledge, and skill—especially in areas outside of their expertise. Investors must seek and weigh qualityfeedback and stay within their circle of competence.
2. Anchoring and adjusting. In considering a decision, we often give disproportionate weight to the first information we receive, hence anchoring our subsequent thoughts. You can mitigate this risk by seeking information from a variety of sources and viewing various perspectives.
3. Improper framing. The decisions of investors are affected by how a problem, or set of circumstances, is presented. Even the same problem framed in different, and objectively equal, ways can cause people to make different choices. Framing, too, plays a central role in assessing probabilities.
4. Irrational escalation of a commitment. Investors tend to make choices that justify past decisions, even when circumstances change. To avoid this trap, investors must only consider future costs and benefits.
5. Confirmation trap. Investors tend to seek out information that supports their existing point of view while avoiding information that contradicts their opinion. Psychologist Thane Pittman’s slip of tongue sums it up: “I’ll see it when I believe it.”
You must also understand how you tend to react under stress. People with different personality profiles behave in dissimilar ways when stressed. Here again, self-awareness and some basic techniques to offset suboptimal behavior go a long way. Pearson declares, “A gambler’s ace is his ability to think clearly under stress. That’s very important, because, you see, fear is the basis of all mankind....That’s life. Everything’s mental in life.”

2 comments:

sunny said...

I have been visiting this site for last coule of weeks and i found your advices and stock picks hot, though i have never picked any of the stocks this far.

I would like to have your views on the indian stock market as a view is gathering around of a bearish phase engulfing the market for a long run by jan-feb 06 with fii moving to other greener pastures.

Also i would like to know what is the time frame for a short/medium term calls you give (in no. of days that is).

Could you also give me some long term investment advices.

R. John Christy said...

Dear Mr. Sunny,
Thanks for your message. I would incorporate your comments in the coming days. Thanks for visting my blog. Keep coming. Thanks again.
With regards,
R. John Christy

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