Many are always looking for the “right” answers: What is the situation now? Is this the right time to buy? What to buy now? Is this the right time to sell? What to sell now?
Every investor and trader believes they are right. We take a position believing it is right and it will result in profit. We believe that being right is important in investing/trading and thus, the search for “right” answers.
Defining “right” and their biases
Every investor and trader believes they are right.
The market represents a huge diversity of views with various thesis. There are always many different and conflicting views by everyone.
- When someone sells and another buys, this represents two opposite views of the markets happening concurrently with both the seller and buyer believing that they are right.
- Also, different investors who buy the same stock at the same time can have different views and expectations.
- Investors and traders on the side waiting also have their different views.
Different views are shaped by their views of the future, the underlying assets and the world; with different time frames and generated in many different ways: charts, their understanding of the economy, the assets themselves, their risk-rewards preferences, etc.
As there are always different and conflicting views, cognitive dissonance is a common occurrence when investors/traders believe in two contradictory things at the same time and are unable to resolve them; leading to uneasy feelings, confusion, stress and irrational decision-making. Cognitive dissonance can weaken conviction creating greed and fear; resulting in sub-optimal buy and sell prices that could lead to losses.
Financial success requires two things: Mastering our mindset and perfecting our skills. A very important purpose of a well-defined strategy is to stay focused and keep emotions at bay.
I am right.
When we believe we are right, confirmation bias can arise. The latter is the tendency to actively search for, interpret, and retain information that matches and reinforces our preconceived notions and beliefs. It flourishes because it is an efficient way to process information, promotes self-esteem, and eases stress by eliminating conflict and contradictions. We have to be aware of their own tendency toward confirmation bias as they lead to poor decision-making, missing chances, and avoiding falling prey to bubbles.
Seeking out different views and avoiding affirmative questions are two ways to counteract confirmation bias.
No, I am right!
Once we believe we have made the right decision and buy, sunk cost trap/fallacy can occur. Sunk cost trap refers to a tendency for people to irrationally follow through on an activity that is not meeting their expectations. Investors fall into the sunk cost trap when they do not want to lose the time or money they have already invested, instead of cutting their losses and making the decision that would give them the best outcome going forward. Many investors are reluctant to admit, even to themselves, that they have made a bad investment. Changing strategies is viewed as admitting failure. As a result, many investors tend to remain committed or even invest additional capital into a bad investment to make their initial decision seem right and worthwhile.
I don’t know. I am not sure. I may be wrong.
While we believe we are right about our investing thesis, we are unlikely to know every factor affecting the investments and their impact, especially as retail investors. Sometimes, they are relevant and important that warrant further study and re-calibrate our thesis. Sometimes, they may not. It is normal not to know all the issues and their specific impacts. We have to decide what is important that will influence the potential of the investments.
“I don’t know” “I am not sure” “I may be wrong” are important to acknowledge:
- the different views and questions being expressed which are a useful sounding board to counteract any biases we may have
- the possibility that important factors may have been missed
- the impossibility to know everything affecting the investment decision and this is normal
No one is always right.
No one is always right and few have the same views; not even legendary investors like Warren Buffett, Charlie Munger, Ray Dalio and Bill Ackman. There will be mistakes and misjudgements.
If no one is always right, what is “being right that we are seeking? They are more right than wrong and at times, we seek the “right” answers to affirm our decisions (confirmation bias).
Develop your meaning of right; develop your game
A trading/investing strategy is about answering these 6 questions:
- What to buy?
- What price to buy?
- How much to buy?
- What to sell?
- What price to sell?
- How much to sell?
The selling questions serve two purposes: (a) to achieve profitability and (b) what if the thesis is wrong.
Everyone has different answers to the above 6 questions even among the great investors. Everyone plays their different (investing/trading) game. There are no rules in investing/trading other than those we define ourselves or we use rules of others. Investing is personal. What works for someone may not work or be preferred by another. Play our own game and make money.
As retail investors, we may start investing/trading with the education, experience, knowledge, time and resources we have compared to the professionals. We need to find our circle of competence and develop our edge.
My investing/trading strategy does not mean that it has to be the best, most profitable or the holy grail. Rather, being a retail investor, the strategy needs to be just right just for me to feel comfortable and confident. We have to build our own investing/trading strategy with our independent thinking and conviction; not influenced and persuaded (easily) by others having different views and strategies.
There is no (universal) right or wrong, only right and wrong we believe them to be and make decisions with.
To be right, be prepared to be wrong and vice versa
Every attempt to profit has a probability to lose. Profits and losses are not separable. As investors/traders, we cannot be overly focused on getting right (the upside and profits); we have to be equally prepared for being wrong (downside and losses).
Rule number one: Never lose money.
Rule number two: Never forget rule number one.Warren Buffett
Rewards and risks have some corresponding correlations. To earn superior returns, we have to be willing to accept the risk of sub-par results when wrong. Most great investments begin in discomfort. For a potential superior reward investing/trading opportunity that we believe to be right against market consensus, we must be prepared to be wrong. To hunt for great rewards, there will be corresponding risks to be taken into consideration.
Check out this post: Everyone is different and needs to have their own investment strategy to succeed.
Focus to be less wrong and more right as a whole
We can lose in the following manners:
- Position size: Position size of profitable positions versus losing positions
This happens when we are unsure and sized with smaller allocations which turn out to be right and profitable. Unfortunately, we can be greedy where we leverage and/or size larger positions which turn wrongly into losses.
One approach is to have equal position sizing.
- Win-loss ratio: Number of winning positions versus losing positions
No one is always right. It is impossible to have 100% profitable positions; there will be losing positions.
- Profitability per position: Profit made versus loss incurred per position
It is a case where we sell our winners too fast earning a few percentages and holding losers too long losing a lot more percentages. Usually, together with a low/poor win-loss ratio (point 2), this is a major reason for losses in investments and trading.
Successful investors/traders may not have a high win-loss ratio but they can make up with a good profit per position by having several multi-baggers and/or they have strict cut-loss discipline.
It is often about the win-loss ratio and how much we make or lose in each position that makes the big difference.
When we first started investing/trading, we had more losing positions and may have huge losses in each position while our profitable positions are less and each makes lesser profits. We have to improve our win-loss ratio, reduce our losses and improve our profits with each position. We need to keep improving our investing/trading skills and strategies to ensure an overall net profit.
To be successful is more than being right. It is also important (and can be more important) to be less wrong. We make profits by being right. However, if we lose more by being wrong, we are in a net loss position. Hence, to be profitable in investments/trading, it is more than being right. It is about how much we make when being right and how much we lose when wrong.
This helps me significantly with my investing/trading: One thing I do that transforms my investment/trading journey
Being probabilistic and not deterministic
Returns from investing are not guaranteed. Our investing may not work out to what we expect. We can be wrong.
Every investing/trading strategy and decision we make is a prediction or a forecast. We aim to improve the probability of our prediction (increase the odds) with our investing/trading decisions to as high as possible to a level that we are comfortable with; as near to 100% right but it will never be 100% right. We have limited time and resources to study and there are many assumptions, uncontrollable and a future that we may not envisage well.
Strong opinions, weakly (or loosely) held
Most of us tend to lock into a point of view on things and making us very prone to confirmation bias. What do you do when the environment changes? We must be prepared to change beliefs and opinions, and accept and embrace new ones to adapt to the changing environment.
“Strong opinion, weakly held” is an expression describing a framework developed by technology forecaster and Stanford University professor Paul Saffo. He described the process as:
“Allow your intuition to guide you to a conclusion, no matter how imperfect — this is the ‘strong opinion’ part. Then –and this is the ‘weakly held’ part– prove yourself wrong. Engage in creative doubt. Look for information that doesn’t fit, or indicators that pointing in an entirely different direction. Eventually your intuition will kick in and a new hypothesis will emerge out of the rubble, ready to be ruthlessly torn apart once again. You will be surprised by how quickly the sequence of faulty forecasts will deliver you to a useful result.”
It is a useful default perspective for investing. It is about the ability to embrace the power of definiteness and the power of openness concurrently (overcoming cognitive dissonance and confirmation bias and sunk cost trap). And when we act, we cannot be of two minds. We have to commit and proceed boldly. But to understand the world, we have to constantly learn with new information and data, adapt, and grow, which implies shifting direction.
The illiterate of the 21st century will not be those who cannot read or write, but those who cannot learn, unlearn and relearn.Alvin Toffler
Marc Andreessen, the co-founder of Netscape and venture capital firm, Andreessen Horowitz, is often associated with the term. Being a venture capitalist, he is always looking for start-ups with great business ideas that opposed conventional wisdom. These can be very hard to execute and entrepreneurs must have strong convictions because of the very big bet of time or money or both. However, as the world changes, how will they react?
Be like water.
“Water is fluid, soft, and yielding. But water will wear away rock, which is rigid and cannot yield. As a rule, whatever is fluid, soft, and yielding will overcome whatever is rigid and hard. This is another paradox: what is soft is strong.”Lao Tzu, Tao Te Ching
“You must be shapeless, formless, like water. When you pour water in a cup, it becomes the cup. When you pour water in a bottle, it becomes the bottle. When you pour water in a teapot, it becomes the teapot. Water can drip and it can crash. Become like water my friend.”Bruce Lee
It is not about being right.
Be prepared to improve, change and pivot when we are less right or wrong. Have conviction with flexibility.
It is being open-minded and humble.