Why do we sell low and buy high – Part II
In my previous article, I have described some of our thought process and mind sets when we are buying or selling a stock. We discussed our fear of losing, our cravings to be liked and our need to act now.
My intention in this article is to continue to explore the key thoughts that go through our minds when making a purchase or sell decision, and the key questions that we should ask ourselves but seldom do.
As highlighted in the previous article, throughout our life time we are driven by several psychological factors that may explain why we are not making the right decisions when it comes to buying and selling stocks. In this article, I will expand on the need to be liked factor and will introduce a new behavioral factor that affect our decision process, our tendency to be overconfident, and our need to comply with our previous commitments.
Let’s explore more about our need to be liked.
To be liked or not to be liked that is the question
There is a good reason why we are conditioned and almost addicted to the idea of being liked and, furthermore, why we are fearful of not being liked. Remember your school days, who did you want to be? Did you want to be the kid that was the most popular or the kid that no one would speak with? Did you want to come to the parties on your own or with other kids? How did you like on your school annual trip to sit next to the teacher because no one else wanted to sit next to you?
So, why do we want to be liked? The simple answer is that usually life works much better for us when we are liked versus when we are not liked. Since our early days on this planet, people that used to get along and be liked by other people usually fared much better than the people that were not liked. In our early days taking care of each other was a must in order to survive, and who likes to take care of someone that they disdain? It is very simple, for most of us being liked means having more opportunities to have good friends, better work and in general to have happier lives.
Being liked is a great thing, so what is the problem with that?
Think about the following, if you can purchase only one stock, which stock would you be more likely to purchase:
- A stock that is owned by a group of your friends that recommended it to you
- A stock that your next door neighbor that keeps on mowing the lawn when you take a nap told you about
If you chose the second option, what are you planning to tell your friends when they ask about it? Or even worse, how would you feel when they will brag about the big success they had?
Not an easy answer.
As oppose to the great benefits of being liked as part of your place in society, Making an investing decisions based on the level of likeness that you will obtain is not always a smart move.
When making the investment decision, we need to ask ourselves some of these questions:
- What is the value of the company versus its current price?
- What are the company future prospects?
- How effective is the company management?
- Do I really know enough in order to make a smart decision? If not, where can I learn more?
In my next article we will discuss these questions, and the famous Mr. Market figure as told by Professor Benjamin Graham. Stay tuned.
For now, we tend to like people that provide us with value and knowledge, answering the above questions and discuss it with your friends will allow you to make savvier investment choices, and furthermore, will increase your likeness based on your valuable knowledge.
Overconfidence and commitment
Do you think most people are confident in themselves or not? You might find it interesting to learn about these findings:
- In a study that was conducted in Sweden by the University Of Stockholm, the subjects were asked about their competence as drivers in relation to a group of drivers. It was found that 88% of the participants believed themselves to be safer than the median driver.
- 19% of Americans believe they are among the richest 1%
- 81% of new business owners think that their own business has at least 70% chance of success, but only 39% think that any business like theirs would be likely to succeed- Microeconomics / Boyes
The U.S Census Bureau reports that 50% of new ventures close within the first four years.
How would you answer the above questions?
Confidence is very important in making any decision, and lack of it can prevent us from making even simple decisions. However, overconfidence, and especially overconfidence that is not backed without key facts, can be fatal to your investment results.
On top of us being overconfident, we also tend to commit and even anchor to our previous decisions.
Think about the following
- Will you be willing to buy a stock today that was cheaper 6 months ago?
- Will you be willing to sell a stock that you own and is now priced at half its high price per share it have reached 6 months ago?
In 2004 shareholder meeting Warren Buffett said: “I bought something at X and it went up to X and 1/8th, I sometimes stopped buying, perhaps hoping it would come back down. We’ve missed billions when I’ve gotten anchored”
The mix of our overconfidence in our selves and our tendency to anchor and commit to our previous decisions can lead to undesirable results with our investment decisions.
What can we do to avoid that?
The first step is to acknowledge these traits and not be fooled to believe that you are different, as Richard Feynman said “The first principle is that you must not fool yourself – and you are the easiest person to fool”.
Other ways to avoid these psychological factors when investing:
- Before purchasing a stock, write down why you decided to purchase that stock at this price and what will make you sell the stock.
- Use check lists to make sure that you covered (and checked) all that you want to know about a company before making a commitment
- Keep searching for new information (and especially information that do not agree with your theory)
- Admit mistakes
What should you check before purchasing or selling a stock? How do you know the value of a company? Why it takes longer for people to plan their vacation than to purchase a stock? I will answer these questions and many more in the next article.
Avitzur Asset Management, LLC
[box type=”bio”]Amir Avitzur has fallen in love with Metuchen in 1998 and has been a resident of Metuchen since that time. Amir is married to Sharon, a local Yoga Instructor and an author. Sharon and Amir are proud parents to two Metuchen boys that are currently on the Metuchen swimming team. Amir has founded and is the president of Avitzur Asset Management, LLC an investment advisory firm in 2004, and provides investment advisory services to Metuchen, New Jersey and New York residents.[/box]
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