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Turmoil in Financial Markets: decision-making bias in trading

Posted: Wed Jun 10, 2020 11:49 am
by silmcoach
[Originally posted December 2018. Plagued by nasty bots, so copying selected posts to duplicate Topic, hopefully to break bot link]

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.]

Re: Turmoil in Financial Markets: decision-making bias in trading

Posted: Fri Jun 19, 2020 9:24 am
by silmcoach
[Originally posted 15th April 2019]

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


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

Re: Turmoil in Financial Markets: What dip? The machines kick in!

Posted: Fri Jun 19, 2020 9:29 am
by silmcoach
So much for a drift down in the markets, the opposite has happened, they have bounced back. But the bounces have been instant on markets opening. That suggests the machines kicked in.

[First posted 30th August 2019]

There appears to be an interesting tussel between sentiment and machine trading. I guess you need to know the logic of the algorithms that control the machines, and to understand the logic you need to understand the minds of those who make up the rules to code. So, what might be the criteria to initiate buy or sell?

As a novice I can only go back to first principles. Why does anyone buy shares or put their money into funds, which after all is a risky thing to do? I guess the most obvious answer it is to profit. For me, it's about getting a higher return than the minimal amount of interest paid by savings accounts and gaining a considerable tax advantage/government contribution. For professionals, it's their livelihood, either profiting for themselves or managing other peoples money.

The eye to profit can either be short or long-term. I'm inclined to think short-term gains are for the machine buying of shares for quick profit, and long-term for humans like me who are more inclined to invest for the long-term. You can't program sentiment or fear of losing into a machine, or the long view, because the future is impossible to predict (consider Trump's tweets, you can't take account of his future thoughts in an algorithm!). What you can program are rules. To profit on shares you need to compare share price to company value. The rule has to relate to this balance. If price lower than value, buy, if the opposite, sell.

No human can calculate this price/value ratio for all the shares in a fund overnight, but a machine can. Perhaps this is why the greatest price movements occur on the markets opening first, then human sentiment tweeks stock prices through the day?

It is unlikely that the U.S./China Trade War (and that is what it really is) will end any time soon, if ever, and so market volatility will continue. The only profit I have made so far is buying in the dip. I accept Kahneman's assertion that humans have an aversion to loss, but I'm not so sure about hanging on to winners in a prolonged period of exceptional market volatility. If I had sold up when I wanted to, and then bought back in when I did invest some more cash, then the value of my portfolio would certainly not have fallen as much as it did. Age does come into it though. If you have twenty or thirty years to go before retirement then I guess all this attention to the markets is pretty much a waste of time. Just hang on to winners.

Will give some thought to this. Now the following morning. I think my strategy, staying true to Kahneman, will be to raise the bar on what I determine are losers. I will sell those funds that dip the most, (when they return to profit that is). I have noticed that my best funds dip very little. I will obviously take into account charges, return and growth, as well as maintaining a good spread.

Re: Turmoil in Financial Markets: Taking stock

Posted: Fri Jun 19, 2020 9:37 am
by silmcoach
[Posted 2 January 2020]

As I follow the markets for now with interest it is time to reflect on my thinking about the stock markets and this experiment concerning loss aversion.

I started as an "experimenter" testing Kahneman's theory that humans are innately averse to loss. I stayed true to this hypothesis, strictly selling losers and holding on to winners, the counter strategy he suggests to avoid falling victim to loss aversion bias. I was okay up until late November, when I began to feel anxious about the lack of any US-China trade deal, and the fact that at the end of 2018 the markets had lost about 25% across the board because of the dispute. It was at that time I bought into several funds, some of which have gained that 25% over the year.

Throughout the year the markets were fairly volatile with significant troughs and peaks. The Dow rose and fell but ended the year up a record 26%. My FTSE tracker rose 19% and my Global funds on average rose as well. Had I stuck to Kahneman's strategy and not sold a majority stake in all but one of my funds (a bond one) I would have increased my investment gain of £376.92 by another +£48.80 +2.2% (on an average investment of around £3K over the year; excluding government bonus contribution of £720). I can't really complain about that. But the thing is, that is me from an "investor's perspective" talking, not the objective experimenter I started out as.

Now the question is, does this switch in perspective invalidate the experiment? Does my switch from an objective strategy to subjective intervention ruin the aversion-to-loss bias experiment? I think the answer comes down to perspectives again. If you take another objective step back and consider the investor from the objective experimenter's position, then the human aversion to loss is "proved" yet again. The experimenter, who due to limited personal funds was taking a significant personal financial risk, could not remain objective.

Perhaps this is an insight into why markets are moved more by sentiment rather than economic fundamentals. There appears to be no correlation between the economy and market indices, certainly not in 2019. So now I'm wondering if the effects of tariffs on China's economy in 2019 will begin to kick in through the Spring of 2020, regardless of whether a trade deal is signed or not.

Kahneman proposed a logical rule that should be followed regardless, hold on to winners, but sentiment, driven by unconscious fear and intuition over-rode that and appears to be doing it again. I'll hold on to my cash for the moment. Guess I fail miserably as an experimenter, but maybe a little more successfully as a prudent investor! My excuse is age. At 71 there may not be time for any significant collapse in the markets to recover in my lifetime. Guess I'll just enjoy my days out, there's far more to life now than worrying about money.

Re: Turmoil in Financial Markets: Wind of change?

Posted: Fri Jun 19, 2020 9:40 am
by silmcoach
[Originally posted 7th Feb 2020]

Is this the turning point?

After softer gains on the US markets last evening (GMT), falls began overnight in Asia, and continued in Europe on opening this morning. With the realization that the coronavirus will not be going away anytime soon, sales warnings in the luxury goods sector, and supply chain concerns for major manufacturers, sentiment may now turn negative. Friday's close, and Monday's opening will give a good indication of how negative that might be.

My inclination before the 8 a.m. deadline (to sell funds today) was to cash in and secure the gain, but as the objective experimenter I'm going to stick with Kahneman and hold on to "winners".

Guess I will just have to steel myself for the appearance of red on my account summary, resist my subjective innate aversion-to-loss, and hang on to what I define as winners, even though they may show a loss in the short term.

Re: Turmoil in Financial Markets: That's all for now

Posted: Fri Jun 19, 2020 9:42 am
by silmcoach
[Originally posted 20the Feb 2020]

Megan Greene, Harvard Kennedy School of Government, was asked about the markets continuing to do super well despite the coronavirus threat to the economy. Might investors be confused by this? She acknowledges that:
... the coronavirus outbreak is certainly having an impact on the global economy, but it is hard to quantify, so equity investors are leaving it out of their assumptions for now. But generally, beyond the coronavirus, if you run correlations between the equity markets in the US and the fundamentals underlying the economy there is about a 7% correlation which is incredibly low, in fact it's the lowest it's ever been. So there is a sort of a disconnect between what's happening in the markets and what's happening in the economy broadly.
Compared to the SARS outbreak, Megan was asked what impact the coronavirus might have on the global economy, she thought:
... it's hard to say, because the coronavirus is still spreading and there's still quarantines, and so until we know the extent of this it's hard to really quantify the effect on the economy. My guess is that it will be larger than the SARS virus, but we can sort of adopt some ideas from what we experienced from the SARS virus. One, for example, is that demand in China fell off pretty significantly in the face of the SARS virus. But if you actually look at retail sales for example, they bounced right back a few months later. We do know that some consumption ... will be purchased, so there could be a payback at the end of this coronavirus pandemic.
She also felt that:
... once the virus has passed it seems like demand could come back, also in China in particular, one thing we do know is that the authorities are going to do whatever they need to do in order to stabilize the economy and so we can expect policy measures to try to offset some of the implications.
BBC News, Beyond 100 Days, 7pm 18 Feb 2020

Re: Turmoil in Financial Markets: Over

Posted: Fri Jun 19, 2020 9:49 am
by silmcoach
[Originally posted 12th March 2020]

As the Sydney ASX All Ordinaries market virtually collapses, losing nearly 10% by mid afternoon (Aus time), it's more than likely European, then the U.S. markets will bomb later today. I think it's time to bring this exercise to a close.

My conclusion is that Kahneman's hold-on-to-winners strategy is not a good strategy for all circumstances. I think you ignore gut feeling at your peril.

My gut feeling (as argued here) was to cash in when the markets peaked in February because prices did not reflect economic fundamentals. But I wanted to remain the objective experimenter testing the theory. In that rational frame of mind it seemed reasonable to buy back funds for less than I sold them as markets dipped. The problem was they kept on dipping. Now I'm spent up the markets continue to fall. All I can do now is hope that eventually the markets recover (could be a few years!).

Had I listened to my gut feeling I would have secured my gains selling all my fund holdings, held cash, waited for the worst of the crisis to be over, then reinvested in the final dip range.

So, we do have a slow system 1, and a fast system 2, but we have to remain flexible and alert to risk, ready to respond in a flash when necessary.


Stocks sold November 2019 £1,944 (gain £250 including cash dividends). Had I held on to these winners I would have lost £273 on them by 8 a.m. today.
Remaining stocks held since November 2019 £1,304, current loss £189.
Stocks purchased during recent market falls to date £4,037

Total current holdings £5,341 showing a loss on paper of £381.

Had I held onto all my winners (instead of selling some) the total loss this morning on £3,248 invested would have been - £462
But by selling winners for a £250 gain, then buying them back at a lower price, (and increasing my holdings to £5,341), my total loss of £381 is reduced by the £250 gain, so a net loss of £131.

Re: Turmoil in Financial Markets: Black Monday - 2 months on

Posted: Fri Jun 19, 2020 9:51 am
by silmcoach
[Originally posted 23rd May 2020]

Well, the markets crashed on March 23rd., what I call, Black Monday (I think that label's been used before)!

On paper my loss was £1,187 (less the £250 I'd banked) on £6,029 invested, so a net loss of £937. It's been painful following the markets, but at least they have steadily gained such that my current loss this Bank Holiday weekend stands at £400.89p, less the £250 banked, which is a net loss of around £150, which I guess isn't too bad.

Had I not bought back in chasing dividends and just put the lot in the Dow I would have been up 18% = £1,085 as well as the £250. Hindsight is a wonderful thing, and I did actually consider doing just that, but hey ho, I didn't, so that's that.

Right, brush off the dust, take stock of how things are now. and decide how to proceed. I know it's sad, Bank Holiday weekend thinking about money, but I promise you I will get out into the New Forest later for a nice long walk. I just happened to set up a new computer this morning and wanted to set up a redirect on to https as all my knowledge base files point to http. That done, curiosity got me looking at again. and motivated me to post this reflection.

Now you might find this a bit bonkers, but I had a couple of dreams last week. The first was my swimming out in a rough sea, and as I rose on the crest of a big wave I could see in the distance a tsunami headed to shore. The second dream, a couple nights later, was about a chap on a motorbike going hell for leather to get out of the City of London. Now whether you believe in premonitions, or think the unconscious was processing my fear, I can't help but be influenced by these dreams which were more vivid than usual.

My inclination is to sell everything. I have no fear about missing out on rising stock prices. The continuous rise of the markets over the last 10 years or so is a thing of the past. I suspect we have 10 years of volatility in the markets ahead of us, so this calls for a new strategy. Contrary to the "hold-on-to-winners" strategy I am going to be dipping a toe into the markets and out again quick, satisfied to make 2-3%. The reason is that even my Cash ISA is now only paying 0.01% interest, so I thought I might as well transfer those minimal funds (cash) into a Stocks and Shares ISA.

Now the interesting thing is that because there is no 25% contribution from the government I no longer have that "safety" margin. Even when I was £1,100 down on the SIPP it wasn't actually a net loss because that loss was set off against the 3 x £720 government contributions. So the SIPP continued to show a profit in terms of net contributions. Now with the ISA, a pound loss is an actual loss, and even though I only put £100 into each of three funds (with ex-dividend dates of 31 May and 6 June) it hurt when two of the funds rose 3% before the valuation point, then promptly lost 2% the next day. That's a lesson learned! So, I will sell after the ex-dividend dates, as long as I am 2-3% up, or even 1% up on the dividend, which if I then hang on to the cash for a year is still a far better return than the Cash ISA of 0.01%; And if they do introduce negative interest rates, well ...

As to the SIPP, I will apply the same strategy to funds in profit with the earliest ex-dividend dates. Those funds currently showing a 15-20% loss I will hold, content to receive the regular dividends. As it is, they are actually the funeral fund, so hopefully they won't be required for a while, and when they are they might even be back in profit!

The New Forest beckons. Have a great weekend every one.

Re: Turmoil in Financial Markets: Sell, sell, sell

Posted: Fri Jun 19, 2020 10:53 am
by silmcoach
Definitely jittery about future outlook.

My L&G US Dow Tracker, is now only 1% lower than it's peak before the Covid19 pandemic raised it's ugly head - so where's the sense (economic or other) in that? So I'm selling. Think it still comes down to there being no where else to put cash, other than gold or collectables.

Now I'm back in profit, my strategy is to wait in a dip sat on my board (cash in hand), catch a wave coming, ride it, and bow out before it breaks. Be content with a quick profit, even if small. Better than crashing out!

My Dow Fund was up 21%. Also sold a UK fund at a 15% loss, but held out till passed the ex-Div date, same with the Dow.

Just left with three stinkers but they all pay 4% plus p.a. Ex-div date end of month, so might as well hang on till then.

Forecast is sun all next week. Guess where I'll be heading, it definitely won't be in front of a computer screen.