3SOF

Investors May Let Emotions Drive Decisions
By ELLEN SIMON, AP Business Reporter, Sat Dec 3, 3:54 PM ET

NEW YORK - Many Wall Street professionals see most people in the market as a herd. If the herd is heading one way, they say they'll head the other. As a result, they can't get enough polls gauging how people feel about stocks. If the majority of investors love stocks, the pros take that as a strong sign to sell. If most investors hate stocks, that's a reason to buy. The smart money says it will do the exact opposite of what everyone else is doing, because logic and experience dictate that investors who stay with the herd often get trampled. But history shows that investors — both professional and amateur — too often let emotions drive their investment decisions.

More on that later. First, let's look at market sentiment indicators, Wall Street's chief measure of which way the herd is heading. Sentiment polls are a mini-industry. Strategists at firms including UBS AG, Citigroup Inc. and Wachovia Corp. look at sentiment indexes. There's the UBS Index of Investor Optimism, Citigroup's Risk-Love Indicator and the Ned Davis Crowd Sentiment Poll, which Wachovia uses. There are enough polls that Schaeffer's Investment Research throws a combination of polls into an algorithm that tries to time the top of the polls. "I probably have 30 or 40 market timing indicators that are sentiment based," said Chris Johnson, manager of quantitative analysis at Schaeffer's.

In looking at the polls, the strategists try to stay one step ahead. "Think of the investor polls as a crowded theater," Johnson said. "If the polls are telling us everyone is in the market, then, if the smallest thing happens, everyone tries to run though one door." Said Whitney Tilson, a value investor and founder of Tilson Capital Partners, "My guess would be that for every 100 people looking at the polls, maybe nine are using it to pile in." The rest use it as a contrarian indicator. In recent weeks, sentiment has been high. Yet, stocks have been rising, a sign the pros aren't fleeing the market.

Why? When it comes to outsmarting the market — or almost anything else — Tilson has argued that we all suffer from overconfidence. In a popular presentation, he says that 82 percent of people say they are in the top 30 percent of safe drivers; 82 percent of Harvard Business School students say they are better looking than their classmates and 68 percent of lawyers in civil cases believe their side will prevail.

Much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process. However, researchers have uncovered a surprisingly large amount of evidence that this is frequently not the case," Tilson wrote in a paper called "Psychology & Behavioral Finance."

One problem: We're too emotional. A study published in "Psychological Science" co-authored by professors at Stanford University, Carnegie Mellon University and University of Iowa pitted people with normal brains against people whose limbic systems, the brain's emotional center, were impaired. The paper asks whether a neural systems dysfunction that curbs emotion can lead, in some circumstances, to more advantageous decisions. The answer, in terms of investing, was yes.

Subjects were given $20 in play money to invest, $1 at a time. Determining whether the investor won or lost was done by coin toss. Heads, they won; tails they lost. Losers lost the dollar they had invested. Winners had $2.50 added to their account. The rational thing to do, since there's a 50-50 chance of the coin coming up heads each time and the returns for winning were greater than the returns for losing, would be to invest in every round. But people with normal brains did not behave rationally. They became more conservative when they lost. People with impaired limbic systems did not. "Medical study confirms brain impairment HELPS improve investment returns," Ajay Singh Kapur, chief global equity strategist at Citigroup, wrote in a summary of the study. He uses the study as an argument for fighting instinct and getting into the market when investment sentiment is most negative and exiting when investor sentiment is high.

It's a rational argument. But think back to the last bubble: Big time money-managers took just as many lumps as day traders in boxer shorts. Most pros didn't stay ahead of sentiment. Most pros didn't bail out when it became clear valuations were irrational. Following the crowd or running from the crowd isn't as solid a strategy as buying good stocks at cheap prices and waiting for them to rise, Tilson said. "Contrarians, value-oriented investors, they look at intrinsic value," he said. "They don't play games with sentiment, because that's inherently a short-term game."

He is currently investing in McDonald's Corp., Wal-Mart Stores Inc., Costco Wholesale Corp. and Microsoft Corp., stocks that have been overlooked in recent months because most investors have been hunting for bigger gains from riskier stocks. Yes, he and his firm are making a bet against the general consensus, he said. "That being said, we're just doing stock picking." His paper wraps up with a series of quotes. One of them is, "The human mind craves clairvoyance, but anyone's ability to see the future is extremely limited."

QuoteThe rational thing to do, since there's a 50-50 chance of the coin coming up heads each time and the returns for winning were greater than the returns for losing, would be to invest in every round. But people with normal brains did not behave rationally. They became more conservative when they lost.

I question whether the people with "normal brains" really had normal brains. Only an idiot would not bet on every flip of the coin with those odds. Is it a statement about our society today that idiots are now considered normal? Just something to ponder on a cold December night....

If "normal brain" is a prerequisite for successful stock trading then I guess some of us are eternally damned!  lol

Most bad moves I have made in trading have been fueled by emotion. Take fear and greed out of the equation and I start finding some sense in the process.

Applauds for posting this article SETRAVIS - I found a link to 3SOF on the Yahoo MBs - probably GNBT, around the beginning of January and that's when I first read it.
I've been keeping the message of this article very much in the forefront of my observations and decisionmaking over the past 3 months, and thought I'd check in with my two cents on the subject.
I find it hard to separate emotional involvement in my investment decisions,  so rather than ignore it, I at least have an open mental debate that includes my instinctual desire to act on 'gut feeling'. 
I think at this stage in my trading career (very nascent) I am still seeking the sources of information to base my decisions upon. [Where DO you people get the heads-up about companies?  I'm very curious to know about this - are these computer programs that run active screeners?  Is it all MB chatter from people who are better-informed than the rest of us?]  With OTC stocks, locating relevant information is just that much more challenging and leaves me feeling like I'm shooting from the hip on occasion.  Those occasions are when I feel most vulnerable to following the herd (GZFX), curious about what they know that I do not.  Knowledge is power; trusting the herd mentality is definitely the opposite of that!  I don't know at what point I would ever be completely confident in buying a position unless I was somehow connected to a company insider (including employment there) - and obviously that raises some other issues... so, what's an acceptable level of knowledge, then?
I think it is noteworthy that the large firms conduct these sentiment polls!  Ironic that the results end up essentially being used against the better interest of those polled... talk about herd mentality when asked to participate in one!  Recently I read something about smart money following dumb money... taking advantage of the trend but being in awareness of what is creating it; probably a rule daytraders live by.  After watching the minute-by-minute activity of GNBT, NVAX, VPHM - and their Y! message boards for the past two weeks - and particularly all the traffic on them related to STTK, AIDO, NMKT I've made the following observation:  If it's advisable to not trade on emotion - that advice was clearly thrown out the window here!  Would it have been foolish to not check out charts on these penny stocks though?  I held off most of the week as it really did appear to be a flagrant P&D scheme, but I decided to try my hand at trading (I only have a cash account, so my ability to do this right now is limited).  I was in and out of ODT in an hour, made $200, which in hindsight was a fraction of what I could have made - but it demonstrated to me what my level of risk tolerance and anxiety is - that hour-long ride was one I basically shut my eyes on - put a GT90 sale on my position and left the room.  I'm not that risk-averse - this is just my first try at it and I'll build confidence and increase my spreads as the situations dictate; but I invested on a purely emotional level and it was quite a different experience.
I also kept in mind the paragraph above on the coin-toss experiment.  I really thought about it when deciding how much of a position I wanted to hold in GNBT, which I got in at $2.40.  If I felt confident that GNBT would rise to at least $3.40, and I was okay with putting $500 into it - why not $25,000?  What emotional barrier was preventing me from seizing the day?  Thanks again for opening this thread with the article, SETRAVIS.  I'll be looking forward to this coming week to see how my 10k-share position in GNBT will play out.  Hey, it's only money :-)
bohemian
BTW - the handle thing is somewhat new to me, so made some changes.  My Y! one is 'runafowl' now (was kyzmet05) - in case anyone cares.  GLTA this week!

In every victory, there is a defeat.  Take Newton's law ,for instance, for every action there is an opposite and equal reaction.  When they stated that billions of dollars were lost in the crash of 2000.  It was an iniquity.  What they neglected to tell you was that trading is a null-sum game.  Meaning that the money doesnt' just evaporate.  It just goes into a strangers pocket.  The lions need sheep.  The lions love slaughtering the sheep.  The emotional traders are the sheep.  We need sheep!  Lots of them!  The problem with sheep is that they are so stupid.  They don't know they're sheep.  This is why there are laws like statutory rape.  A man of 30 surely should be able to outwit a 16 year old girl.  Same is true of the seasoned veterans of this stock trading society, the strong prey on the weak.  The weak only grow strong from giving their money to the strong.  Which is commonly referred to as learning from your mistakes.  Or paying for a subscription to a stock picking service.  One way or another you will always give your money, willingly or unwillingly, to those that either have a very high aptitude suited for trading or those that have dedicated countless hours studying the market or both.  Ever hear the age old adage that there will always be someone out there that is bigger, faster, stronger and/or smarter than you.  If, you aren't on top you're looking up.  Sometimes just sometimes, you can see the top.  Damn those glass ceilings.  You want to learn about sentiment.  Go learn candlesticks.  Don't stop at the hammer.  Please, don't stop at the hammer.  Immitate, assimilate, innovate.  In the mean time follow a lion, whose goal is not to lead you to Slaughter, Webster.

LS

hi,
of course investors let emotions run their decisions. open cnn money every morning and the head line will tell you which way the emotions are swinging . " bad earnings report , futures are down , stocks to open lower"
'Interest rate rise investors run scared" etc. etc. someone says something about gnbt investors run scared . stocklemon says something about sttk investors run scared. no dd done here just plain old fear. fear of losing something that is totally intangible anyway. money.
you can't take it with you. it is totally useless unless you exchange it for something , and that something will deteriorate like everything else in a world of false structure. even making money is a fear of losing . "what if i don't have enough. !" should have waited and taken more profit."
it can never be enough . your emotions run everything you do. even a set stop at a given point that is hit wether it is a trailing stop with profit , a stop loss,  or a target reached this will illicit some kind of emotional response from the trader (i.e. me )
to pretend that emotions aren't involved is to deny  you are human which is impossible to do because then you would be something else in no need of money or anything else in this world.
make any  sense ?
the floor is open

maxi

When investing in stocks, the agony of defeat is much sharper than the thrill of victory.
Several studies have concluded that investors remember the sour feelings of losing money in an investment more acutely than making the same amount of money in a winning investment.

A few losing investments and an investor can become so nervous that good decisions are all but impossible. For some investors, the mere thought of losing money is enough to make them nervous and emotional about investing.

Emotions can play havoc with your investing because they trump logic unless you have a plan that you prepare in advance and commit to stick with regardless of what else is happening.

Bad Investing Decisions
Emotional investors usually make all the wrong decisions for all the wrong reasons.
It's important to note that if you fall into this category (and many investors do), it doesn't mean you can't be a successful investor. It simply means you have to acknowledge your concerns and allow for them in your investing process.

The safest way to do this is to plan your sell strategy before you buy a stock. Decide at what point you can no longer support the stock and mark that as your sell point.

Consider the normal price fluctuations of the stock and how low you think the stock might fall under relatively normal market conditions.

Selling Point
Find that fundamental point and make it your sell point. This is your exit strategy and commit to writing, so that when things get rocky you can refer to it.
With a plan in hand, you can take the emotion out of the sell decision, which should help you avoid holding the stock too long or selling too quickly.

You can put several strategies into place that will help you take some of the emotion out of sell decisions. There is a delicate tension between selling too soon and holding too long.

On the down side, you can only lose 100% of your investment (the stock goes to $0), however if you sell prematurely what you potentially could lose is unlimited because there is no limit to how high a stock can rise.

Investing Strategies
If you are a "buy and hold" investor, and the stock is rising you don't want to exit out prematurely, however you also don't want to see a nice gain disappear if the stock reverses course and begins a sustained downward plunge.
One way to protect profits is to use trailing stops and stop loss orders. These simple trading techniques will help you cover you profits and protect against losses.

These strategies won't "guarantee" you a profit or protect you against an absolute loss, but they will help you take some of the emotion out of the investing process, which will help you make better decisions. Better decisions means betters investments over time.


There is much emotion attached to money and there is no escaping that fact. You can minimize the influence emotions play on your investment decisions by planning your exit strategy even before you buy the stock.

Another thing that I found to work in case of big blows is to have your portfolio as close as possible to dollar weighted.That way down side is distributed equally in your portfolio and so is the upside.

Nice thread, good perspectives shared here.

I am a relative newbie to trading, and have soooo much to learn about the technical side and fundamental side, but somehow I have had a bit of an advantage in the emotional side for various reasons. 

One of these is perhaps trial by fire.  I lost sleep for probably 2 weeks last year after going down something like $26K in about 2 days with a crazy all in strategy with NVAX.  I held to my thesis about the stock, kept looking at my top ten reasons for buying it every day, and eventually sold it and came out about even when it went back up.  So I gained a perspective that makes other types of losses seem more bearable or at least less likely to cause me to panic, and I have the perspective to trust my thesis a bit more.  I now use stops, and if my stock is droping towards them like a rocket, well so be it, I have been through much worse and still survived.

Another reason my emotions are more calm is years of studying a new field of psychology called NLP (neuro linguistic programing).  One of the great realizations of NLP is that you can control your state of mind, rather than letting external events always dictate what your state of mind is.  To me this was rather revolutionary though self evident in retrospect.  Think about it, most people do go through life being happy when good things happen to them, and sad when bad things happen.  Its all reactive.  But a key tenet of NLP is that you have all the resources inside of you to trigger those same feelings at will.  For example, if you feel down but conciously decide to smile, sing, recall funny jokes, you are controling your mood despite the circumstances.  The more you learn to be concious of your current state at all times, realize what external stimulus caused it and then question whether you wish to allow that stimulus to control you, the more you can easily break out of the cycle of being an emotional slave to circumstance.  Its a way of thinking with your cerebral cortex instead of your amigdula (that part of your mind which gets scared when it sees a garden hose and thinks its a snake, and controls your actions based on instinct and emotion designed to help us survive ancient challenges, but is not that great of a stock trader in the modern age).

Finally, I am reading "Trading for a Living" as doubtless many here have, and Dr. Elder spends a lot of time in the first chapters of the book discussing the psychological aspect of trading before ever delving into the technicals.  He clearly seems to think this is more important than technical knowledge ina and of itself.  I have highlighted all the great advice in these sections, and plan to review them regularly.  For those that havent read this book, and are intrigued by this thread, I hightly recommend this book.

Socrates ain't got nuthin on you guys!

Quote from: Liquid Stick on April 09, 2006, 05:27:24 PM
In the mean time follow a lion, whose goal is not to lead you to Slaughter, Webster.

Hey LS - I just got it LOL. Webster Slaughter, old Cleveland Browns receiver. I knew there was something familiar in that line. . Regarding your lion analogy, would you agree with Natalie Merchant that "until the lamb is king of the beasts we live so one-sided?"

Travis - good point about the agony of defeat being sharper than the thrill of victory. In trading, even when you win it can feel like a loss. For example, when you make 20% on a stock that runs another 200% after you sell. It takes a certain kind of resilience to shake off those emotions. Ever notice how so many traders want to write books about how to trade or start their own stock picking service? Know why? Two applauds to whoever has the correct answer. Here's a hint: it is related to the topic of this thread.

 If there is one thing I've learned about trading it is after you sell a stock get it off the screen and don't look back because I'll be kicking myself in the rear every week if I didn't. Once I learn how to use trailing stop losses effectively then I'll be able to look back with big smiles. 

Quote from: wrangler on April 11, 2006, 08:51:49 AM
If there is one thing I've learned about trading it is after you sell a stock get it off the screen and don't look back because I'll be kicking myself in the rear every week if I didn't. Once I learn how to use trailing stop losses effectively then I'll be able to look back with big smiles. 

I like how David once put it "Stocks are like oranges, I squeeze the juice from them and then move on".  I am sure I will remember that for as long as I keep trading, and it has helped me put losses behind me, and also not to feel bad about those that turned out to have more juice left in them than I had expected.   

I think there is still *some* use to checking in on them every now and then if you still have room on your watch list right after you sold them (so that you have perspective for trading better next time), but this should be a small fraction of the time you spend, you need to focus your efforts on finding the next juicy oranges!  If find that this process automatically flushes the stocks I sold recently from my watch list within a week or so anyway.

I found this link in a thread at 3SoF a while back and bookmarked it. It's "20 Rules to Stop Losing Money" in trading.

http://www.hardrightedge.com/wheel/hrerules2001.htm

One of the rules is...

14. Don't join a group -
Trading is not a team sport. Avoid stock boards, chatrooms and financial TV. You want the truth, not blind support from others with your point of view.

Which is of course very applicable to all of us here. I've got mixed feelings on that rule. Groups like 3SoF make trading more interesting and introduce you to stocks you might miss if you were running solo. On the other hand you are also at greater of groupthink and chasing stocks that have already run up. I'd say groups elevate emotions which can lead to bad decisions.

One real life example for me is ONEV. Two days before 3SoF bought it I had received a PM from a subscriber asking my thoughts about it. I told him I thought it was done short-term and not a good buy. The next day 3SoF introduced it and bought the next open. So did I, against my previous judgement. I was swayed by the groupthink and by the arguments in favor of buying. 

It's a conundrum because I enjoy trading groups. They help keep my interest level in the markets high. I like reading and posting on the boards. But on the other hand I do see evidence in my trading records where it has a detrimental effect. One thing that might behoove me is to just read the subject lines of messages. Get the ticker, plug in into Stockcharts, and make a decision. Don't open the message and thereby receive input that can affect my decision making. This would be hard to do because I like reading the messages. Can't I have my cake and eat it too??

 They say it is good to find someone who can separate his emotions from trading in this business. They would never hire me. On the contrary, I believe if you show me a good loser, I'll show you...a good loser. I don't want to get good at that. I work in my trading office with every ounce of my energy and focus. I enjoy getting out of bed around 5 am with no alarm clock for a reason...I love coming to work. I love hating some moments of that work. I love being driven to the point where I physically feel my poor decisions in my back (a good sign I need to change my position). I love the fact that I get to rap all day long with some of the brightest minds on the planet... many of whom you read on this site "3SOF"...and disagree, agree, debate, and challenge. To do any of that without emotion would be on the day before I should not do it at all.

So, when I have an awful day, I feel awful. One of my trading rules is to do the exact opposite of what I used to do (the reason to keep a trading diary) and leave the office early. 

But, I'd like to think they were born from a trading rule I took very seriously, had a blast doing it, and one that I recommend to anybody else. After a terrible day, leave early and make it two different days.