Turmoil in Financial Markets: decision-making bias in financial trades

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Turmoil in Financial Markets: decision-making bias in financial trades

Post by silmcoach » Thu Dec 27, 2018 12:45 pm

The UK Government has legislated that employers must automatically enroll all employees (meeting certain criteria) in a work-place pension scheme. In some cases this may be a stakeholder or self-investment personal pension that the employee manages him or her self. Understanding how people tend to make decisions about money may therefore facilitate prudent investment strategies, particularly if the investor knows little or nothing about investment in financial markets (as is true in my case).

The current turmoil in the World's financial markets would appear to be related more to a fear of losing money rather than any rational consideration of economic fundamentals. Given the complexity and nigh on impossibility of deciding with any certainty whether the market will rise or fall many rely on intuition and gut feeling. But how reliable is a "gut feeling" or intuition?

When it comes to financial risk, human beings appear to have a greater aversion to the experience of a loss. Choosing between a potential loss or gain with the same financial outcome, most will try to avoid the experience of a loss. It is said that the experience of losing £10 would require the finding of £20 to offset the experience of a loss.

In a study participants were invited to make the following decisions:

Scenario 1 Participants were given £10. They were then given the choice to receive another £5, or gamble on the toss of a coin to receive another £10 if they win, but if they lost, only keep the original £10.

Scenario 2 Participants were given £20. They were then given the choice to lose £5 straight away, or gamble on the toss of a coin to keep the £20 if they win, but lose £10 if they lost.

Most decided to keep the certain £15 in Scenario 1, but to gamble in Scenario 2 to avoid losing £5. However, the outcome is exactly the same in both scenarios, if they do not gamble they get to keep a certain £15. It would seem that in the majority people don't like losing. They will stick with a winning streak and take a certain £15 in Scenario 1, but gamble to avoid losing £5 in Scenario 2.

So when it comes to making good financial decisions, whether in the stock market or in general, this insight into the way humans tend to make decisions about money could be helpful, see Bias in the world of money.

I decided to put Kahneman's theory to the test. The Dow Jones fell dramatically in the week 17-21 Dec, my instinct was that this would be a bad time to buy into the Dow because I was likely to lose. But rationally I thought nothing had really changed financially in that week, the US economy is strong, consumer confidence up, it was more about President Trump spooking investors with tweets about the Fed, the budget, the Wall, and the trade dispute with China. I decided to place a £200 order on Sunday (23rd) with a Dow tracker fund, which was priced on the 27th. There was some recovery on the next day 28th, and by the valuation point today (31st) my investment was up 2.62% (I pay no commission buying & selling funds). A reasonable gain, and one which in an ISA would take 2.5 years to achieve. I wait to see what happens to my investment this week, and to another in a UK equity fund (£100, up 0.65%) and a global fund (£200, not valued today - now loss 0.27% 2 Jan 2019).

[This post is absolutely not a recommendation to invest in the stock market. I am personally testing a general theory about human decision making by taking a counter-intuitive gamble. I am aware that stocks can rise or fall and I am prepared and able to sustain any loss.]
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Wed Jan 02, 2019 9:46 am

Interesting - the FTSE plunged 1.75% on opening - I do not believe that is the result of human decision making - possibly algorithms initiated these trades on the market opening.

In 1999 Kahneman wondered why buyers and sellers valued the same share so differently. Things have moved on in the last twenty years - algorithms are an intermediary complication that humans cannot factor into their decision making. Deciding the right time to buy or sell when up against algorithms that can move markets in seconds is beyond human capability; in particular funds, for which the buy or sell price is unknown hours, if not days in advance. Maybe that's why investment platforms stress that any investment should be for the long-term, then inflation guarantees an eventual rise over time (they say 5 years at least) despite fluctuations in the market.

From a SILM® perspective I think this is a good example of how we live in, and have to adapt to, an arbitrary World. New technologies are rapidly changing and disrupting the World which we create, but our natural human responses tend to be the same as those of our ancestors who would often have relied upon a gut feeling in the moment for survival. Our arbitrary World is slower, there is time to rationally consider possible outcomes before acting. But we tend to be lazy, and most of the time allow the unconscious to get on with it.

In this new year more seasoned investors are selling their stocks in fear of recession. Given this insight into a genetic disposition in humans to avoid a loss, my counter-intuitive strategy of buying stocks (via funds) when they are losing their value would seem to be going against the wisdom of more seasoned investors who are selling theirs. We shall see - guess I'm in for the long game.
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Mon Feb 04, 2019 4:18 am

As we go into February my investment in the Dow Jones is up 7%. My instinct is to sell and take the profit. Kahneman suggests the opposite, sell losers. Given that the yield is 1.60% and charges only 0.06% might as well follow his advice. I'm inclined to hang on to my losers for the time being as they are possibly on the rise. As Kahneman says, people hate losing! 😊
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Thu Feb 07, 2019 4:45 pm

My investment in the Dow Tracker had risen over 10% by 3pm yesterday. My natural instinct was to sell and take the profit as dark clouds still appear on the market horizon.

But no - Kahneman says hang on to the winners - sell the losers. As I had two older funds that were within a whisker of breaking even (and had high charges, low yield) I decided to sell them last night knowing the price could rise or fall at mid-day today. Their value actually rose slightly reducing my loss on £200 to 20p. Kahneman was right - I feel very pleased to have hardly lost anything on the investment. :D

I did also invest nominal amounts in three other funds a couple of weeks ago, and they are now up an average of 3.84%. Like the Dow Tracker fund they offer low charges and reasonable yield, so I shall stick with them for the longer term.

I am now waiting for the markets to fall so that l can increase my investment in the winners. The interesting thing is that the last couple of days have seen the algorithms kick in again and there have been greater price swings on the markets opening. I wonder if these machine led sudden rise and falls spook investors such that it takes time for human nerve (investment confidence) to recover and they begin to invest again? :idea: Thus given the human bias of aversion to loss we might expect rises in stock prices to be gradual and falls to be sharper, or even sudden (if panic sets in - as happened when I began this little experiment).

[To repeat - this post is not financial advice - I am merely testing Kahneman's theory]
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Mon Feb 18, 2019 11:25 am

As we start a new week it will be interesting to see which way the markets move.

Last week saw a steady rise in the Dow, my investment is now up 13%, and the other two funds I invested in at the same time ((Lindsell/Train Global & UK; bought 27th Dec 2018) are also up on average about 7%. My losers (purchased end of June 2018 (before I thought about testing Kahneman's theory) as prices began to fall and continued much longer than I expected) have edged up toward break-even. So just hanging on to see what happens today; want to sell at as small a loss as possible.

It seems that last week computers moved Asia and the US more, and sentiment UK & Europe (remember I know nothing about the markets - I am just testing Kahneman's theory - and getting a feel for how things work). I am thinking that as US/China trade talks resume sentiment will begin to kick-in for US/Asia with falls increasing if no positive news as we approach the 1st of March deadline. Now I have understood that with Funds, yields should be taken into account, I am happy to hold on for the longer-term. Accepting rise and falls in winners, with income covering fees, I now regard falls as a positive buying opportunity. One such case was Schroder Tokyo, bought 11th Feb. Up 3.34% and the valuation today at 12 noon should rise as the Nikkei is up 1.82%. (Subsequently this turned out to be a loser and will be sold).

I still feel I want to sell and take profit on the winners, it seems counter-intuitive not to. But Kahneman's point is that intuition is unconscious lazy fast-thinking that's often biased because we naturally hate losing. So I am staying true to Kahneman's theory - holding on to winners and selling losers. I define winners, using slow-thinking and research, as 'good performing, with a decent yield'. Losers as 'poor performing and low yield'.
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Thu Feb 21, 2019 5:36 am

5 a.m. Have placed orders to sell my last three 'loser' funds. Taking a small hit, but I have given enough time to this exercise. Now my winners should provide sufficient income to cover charges and a little bit of profit. So will hold on to them for the long term and hopefully they will increase in value.

The SILM ethos is happy heart, peace of mind, so I don't want to be wasting any more time thinking about money. I shall just keep an eye on the markets and top up my winners in any dips.

So, back to topping up my knowledge and rekindling Spirituality... been away too long 😊
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Tue Mar 12, 2019 5:22 pm

Couldn't keep away. Noticed a bit of a dip in the markets, so bought into 5 of my Watch List funds on Monday (placed order at 6 a.m.) Gambled Brexit might cause UK prices to rise this week, and global stocks were on the bounce. So far so good - but, looking dodgy today - 7pm Brexit vote!

Anyways - all my funds are now income funds, and losers sold - except one, waiting for the dividend payment due shortly. I have an average annual fund charge of 0.425% (and SIPP charges of 0.45% pa) with a gross average income of 3.23% pa (not guaranteed). Any growth in fund values will be cream on top as I've already had the 25% contribution from good old HMRC. That's it for now, will continue to top up my winning funds (eleven in total) in significant market dips. I am also hanging on to 50% cash (as at my age long-term is 3-5years) thinking that any market crash is likely to peak at about 25% (a guess) which would be covered by the 25% contribution from HMRC. I also believe that being in funds is a safer bet for the small investor as risk is spread over a large number of leading companies, sectors and countries.

So, according to Kahneman, I've done the right thing - let's hope I have picked all winners. But even there I have a balanced spread of funds to average out performance. I'll give you an update from time to time. The fund values are up 4.65% from the 27th December 2018 (that's is just under 3 months) when I began this little experiment :D

[To repeat these posts are not financial advice. My sole intention is to test Kahneman's theory that human beings have the genetic disposition of 'aversion to loss' and therefore are inclined to sell stocks that make a profit and hang on to losers. Kahneman says this is a mistake, and the opposite strategy of accepting a loss, and hanging on to profit, is the right strategy. NOTE: Stocks can rise or fall - and you may get back less money than you put in - so they have warned me]
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Wed Mar 27, 2019 5:53 am

Couple of weeks now - we had a bit of a dip end of last week - so topped up one high yield fund just before the Ex-dividend date. Want to see a regular income stream and this funds dividend is paid monthly - it's like I'm always winning, even if it is only 3% p.a. Guess Kahneman was right - I hate losing. A win, no matter how small really does feel good. This is fast System 1 kicking in.

But I have started to consider the longer term gain. This is slow old System 2, strategy thinking 😔 I think there has to be a balance. Keep that lazy System 1 happy 😊 but let the wise old System 2 take a account of how funds have performed over the longer term.

Now my highest gaining fund over 3 years (79.87%) only has an annual yield of 0.5%. So it's a no brainer that gain trumps dividend. But there is no emotional response to this very significant gain - you could say there is no fun in thinking three years down the line. I'm beginning to wonder if I shouldn't perhaps sell the odd winner, take a bit of profit now and then. [Now I know fast System 1 is kicking rational System 2 out of the way, looking for a bit of fun and excitement - that's the adventurer side maybe - the challenge] Of course then I would have to be watching the markets daily, don't think I want to be bothered with that. No, just look to longer term gain and let System 1 have it's cheap thrill seeing the dividends come in regularly 😄 It's all about a balance between System 1 & System 2, the more profitable long term balanced with the better yield and least effort in the short term 😊
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Sun Mar 31, 2019 10:05 am

Decided later in the day (Wednesday) as stock prices falling, to top up three other high yield funds with an ex-dividend date of 1 April. Deals completed next day as markets began to to rise, and Friday they rose further so my portfolio gained 3% over the week.

Remember, l knew nothing about investing in the stock market and I just decided to test Kahneman's theory using my SIPP cash. My gains could just be beginners luck in a volatile market. My Sunday paper Money supplement was certainly full of doom and gloom for the world economy and the UK given Brexit. My instinct is to cash in my winnings, but it would just sit there in the SIPP losing its value due to inflation, and if I withdraw the cash I will have to pay 20% tax. No, decided to hang in there with my strategy for the longer term and enjoy my regular winnings (dividends) to keep System 1 happy, and the longer term gain (hopefully) keeping slow wise old System 2 smugly comfortable. Fingers crossed.
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Fri Apr 05, 2019 7:51 am

So, end of the tax year, and my first 3 months of testing Kahneman's theory, that humans have a decision-making bias in financial trades. How's it going and what have I learnt?
  • In 3 months my portfolio has increased in value 6.80%
  • Developed a strategy of trying to achieve an optimum balance between charges, yield, and growth
  • Buying in dips is difficult to time right, but definitely increases growth opportunity if you do get it right
  • No need to always sell a losing fund (low yield/growth, high charges) in a dip - wait for it to recover to sell at cost or a small profit
  • For me personally, dividends make me feel happy, like I'm winning in the short term (emotion - System 1), growth is comforting in the long term (strategic goal: increase wealth - System 2)
  • Holding cash in a SIPP allows me to buy in dips and like insurance, if the market collapses the most I might lose is hopefully the 25% contribution from HMRC
All in all Kahneman's theory helped me to manage my SIPP more effectively. Selling losers and hanging on to winners made the last three months of my first SIPP year more profitable. :D

Conclusion

I started my SIPP at a time of uncertainty in the markets. After several years of steady rise in value (think that's called a Bull Market) there was a significant correction. Stocks were perhaps overvalued. and falls significant (spooked by Trumps trade war with China, and fears of Global recession). I have therefore been able (lucky) to benefit from significant rise and falls in the markets as confidence gained and waned like a roller coaster. I think it may be more difficult in a relatively stable market to judge the bottom of future dips and therefore miss the right time to buy. Hmm ... guess that's going to be the next challenge. Too complex to figure out rationally. Guess that's where intuition comes in ... must study creativity
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Re: Turmoil Financial Markets: Still up!

Post by silmcoach » Mon Jul 01, 2019 6:03 pm

3-month report. Pleased to say I am still up just under 11% (on £2,400 invested in funds - update 8 July, now up 12.5%). Cash income received of around £17.00 so far this year which covers annual charges for the online platform. I have also received two pension contributions of £720 from HMRC, based on my two maximum annual pension contributions of £2880. I have also taken out a couple of UFPLS (lump sums tax free up to the personal allowance) which I was able to re-invest in the SIPP, thus reducing my net annual contribution.

With my ISA account interest rate being so derisory (reducing from 1.10% to 0.70% in August), I really don't mind holding cash in my SIPP, waiting for the next dip to buy in more. No point in taking it out as I would have to pay 20% tax. Just waiting for Trump to turn again!

It has been tempting this time to cash in and take the 12.5% profit, then buy back in again. But I must stay true to Kahneman's theory - sell losers - hang on to winners. Also buying cheap - this has been Warren Buffets very successful strategy over his lifetime - buy cheap and hang on to your stocks. Like Warren Buffet I've dropped some clangers - some of my losers have actually turned out to be very good winners over the last few months. I needn't have been in such a hurry in my judgement of funds. On the other hand, the strategy saved me from Woodford's funds!

One other thing I read about Warren Buffet; he has advised his wife, on his death, to sell up and put everything in an S&P tracker. Guess what I will be buying into in the dip?
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Re: Turmoil in the Financial Markets: another dip

Post by silmcoach » Thu Aug 08, 2019 12:19 pm

My gain so far this year is 13.5%. I really wanted to sell the lot when Trump spooked the market again with further tariffs for China last week, but I hung in the there, preferring to buy in the dip.

I broke my rule last Thursday of only investing the minimum possible of £100 a time and topped up two of my UK income funds by £200 each, and yes, the very next day they fell again, so I could have bought cheaper. Never mind, lesson learned. Anyway, finally managed to get started with an S&P 500 fund this week, invested £100, and bought back (£100) into an income fund that I had previously sold as it has outperformed funds I'd kept (don't always believe what you read in the financial columns). Also added to the L&G UK income fund £100, pays 4.3% p.a. with charges of only 0.04%, gain 29.6% over the last 3-years (Guess what, bought at 12 noon valuation point and an hour later it had risen .69%. If only I bought £200 - Uh, never satisfied).

So having watered down my portfolio with new investments, and with the recent dip, I am reduced to a 7.5% gain. But of course I would only lose if I sold, which there's not much point in doing because the cash would be stuck in the SIPP as any more withdrawls would attract a tax liability.

Hey ho, let's get back out on that bike before the forecast rain arrives.
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Re: Turmoil in the Financial Markets: decision-making bias in financial trades

Post by silmcoach » Sat Aug 10, 2019 8:37 am

Something I hadn't realised with regard income payments! You only need to hold the stock on the ex-dividend date. You can sell the stock the next day and you still get the divided on the settlement date. So you could literally buy the day before the ex-dividend day and sell the day after.

Handy to know if stocks are falling. Possible to take a profit without losing the dividend and buy back when you think the dip has bottomed out. Of course contrary to Kahneman and Buffet's rule of hanging on to winners, but does increase the chance of selling a "loser" at the optimum time.

I still question the wisdom of hanging on to winners. I do wonder if that applies more to individual stocks. Yet everyone seems to say you should hang on to funds for the long term - at least 5 years as it is so difficult to time buying in dips and selling at a peak.

I think the point is that I've come into the market at turbulent times, what with Trump, Trade Wars and Brexit, when the potential to buy and sell in peaks and troughs is greater. Trying that strategy this week has had mixed results though, but I did learn previously that there is is no rush to sell losers because you only lose when you sell - patience is a virtue!
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Re: Turmoil in the Financial Markets: Should I have sold?

Post by silmcoach » Thu Aug 15, 2019 8:54 am

After yesterday's fall of 3%, more or less across the board, I seriously think I should have sold. Instead, I have bought in the dip again, although my first buys were a disaster, they fell another 5%. The only saving grace is that the dividend is from 4-5% p.a., payable monthly or quarterly. So I just have to disregard the fall in price, which won't result in a loss unless I sell, hang in for the long-term, and watch the dividends continue to roll in, hopefully.

Have also invested today the minimum amount in UK & US tracker funds with very low charges. All in all I have watered down my portfolio so that I am now only 7.5% up. Whether we are headed for recession, given the inverted bond prices, I don't know 😞, but at least I now have a regular income from my portfolio with growth, which was my aim. Still beating my ISA hands down and, not forgetting the point of the exercise, I have stayed true to Kahneman's strategy of 'sell losers and hold on to winners'.

Update 12 noon. Here we go again, Trade war has spooked the markets. Only good thing is that my purchase orders will buy more.
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Re: Turmoil in the Financial Markets: Hanging on in there

Post by silmcoach » Fri Aug 16, 2019 11:33 am

Well yesterday the paper profit on my holdings dropped to 5.28%, a long way down from the 14% gain of a couple of weeks ago.

But true to my investment strategy I made two further investments this morning (before the 8 a.m. deadline for 12 noon valuation), one UK and one Global. These I believe are winners to date. I have also learnt which funds have turned out to be dogs, a fact previously hidden by the general rise to peak prices. My winning funds actually lost very little of their value in the recent fall. I will dispose of the dogs as soon as they break even on the buy price and reinvest in the true winners.

I have come to the conclusion that stock market prices have less to do with economic fundamentals and more to do with the fight or flight response (fear), and this is what Kahneman argues, humans hate losing, and that emotional reponse in the moment overrides a rational view over the long-term. So I just have to hold my nerve, which is made easier by the fact I cannot touch the money for years, unless I want to pay tax on any drawdown.
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