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

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silmcoach
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Turmoil in the 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 of receiving another £5, or gamble on the toss of a coin to receive another £10 if they win, or nothing more than the £10 they were first given.

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, or lose £10 if they lost, so keeping only £10 of the original £20 they were given.

Most decided to keep the certain £15 in Scenario 1, but to gamble in Scenario 2. 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 (Scenario 1) but gamble if they thought they are about to lose something (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.]
silmcoach
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silmcoach
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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 that 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 my 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.
silmcoach
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silmcoach
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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 3% and charges only 0.6% 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 higher yield, so I shall stick with them for the longer term.

I am now waiting for the markets to fall so that can I 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 rise and falls spook investors such that it takes time for human nerve to recover? :idea:

[To repeat - this post is not financial advice - I am merely testing Kahneman's theory]
silmcoach
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silmcoach
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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 Kahneman - 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 !st 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 and income covering fees, and to see 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%

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'.
silmcoach
Greatest wealth - happy heart, peace of mind :D

silmcoach
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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 😊
silmcoach
Greatest wealth - happy heart, peace of mind :D

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