Make Money in Stock Market with Behavioral strategies

1. We all suffer from Behavioral finance brings psychology based theories to explain stock market fluctuations, such as severe rises or falls in stock price. Stock market is the estimates of the valuations of company's ownership and buying and selling happens on those prices. These prices feature an ecosystem of complex human behavior. Though the company results comes once a quarter or any fundamental news or big changes comes once a while still price keeps changing every movement and many times sharp moves comes, behavioral finance explains the reasons of those fluctuations in prices. Day-to-day activities are primarily driven by behavioral patterns. The same behavioral patterns also guide investing actions. We make judgments about markets according to our behavior. Everybody has biases associated within their behavior. It’s impossible to be unbiased in our decision-making. However, we can mitigate those biases by identifying and creating trading and investing rules – but only if we know what to look for. Investing biases fall into two main categories: cognitive and emotional. When we analyze our world without knowing about these biases we tend to take biased decision which generally lead to wrong end results. This complex human behavior is affected by many circumstances that affects our investment decision this behavior of human being to deviate from rational judgment in illogical fashion is explained by Behavioral bias. Below are explained some bias which are present in everyone to various degrees if we remain aware we can build defense mechanism to avoid losses and behave rationally. BEHAVIORAL BIASES George Soros, a highly successful investor, known to account for this tendency by keeping a journal log reasoning behind every investment decision. is of his Point to note is that here is price is set panicked seller and most greedy buyer. investment price is not viewed, the thing to check out is Margin of safety i.e. difference between price and valuation. Price is what we pay and value is what we get- “Warren Buffet”. by most For

2. There are many biases, we have mentioned here only that affects our trading and investment decisions. 1 Loss aversion TABLE OF BIAS 2 Confirmation bias Gamblers fallacy 3 4 Ownership bias 1 Herd Mentality 5 6 Anchoring Bias 7 Recency Bias 8 Overconfidence Bias 9 Attribution Bias 10 Illusion Of control Bias 11 Hindsight Bias 12 Negativity Bias 13 Sunk Cost Bias 14 Bias Blind Spot

3. 1. Loss aversion Bias MEANING: We tend to feel the pain of a loss more strongly than we feel the pleasure of a gain. EXAMPLE: It's this unwillingness to accept the pain that might cause us to: 1. "Ride losers too long" 2. "Sell winning stocks early to take some profits". Philip Fisher wrote in his excellent book Common Stocks and Uncommon Profits that, "More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason." TRADING/INVESTING RULE TO SHIELD THIS BIAS: Looking at losses in a different light is essential for a trader. Losses are merely the cost of doing business. It is like paying your supplier for goods, before selling them to your customers. A trader who does not want to lose is as absurd as a retailer that does not want to stock up on products to sell. If that’s your game, you should to be a broker and not a trader.

4. 2. Confirmation bias / Myside Bias MEANING: The tendency to search for information in a way that confirms one's beliefs while giving disproportionately consideration to alternative possibilities. First we make the decision then we find the information to justify that decision. We do not like information that contradicts our thoughts. We like them when they confirm what we think. Hence, we tend to place more weight on information that confirms our position. We give more weight to things that confirm our thoughts, we become more confident. As a result, we become less aware of the fact that we are affected by confirmation bias. This bias ends in self-deception less EXAMPLE: You think that the market favors a long position, and you want to buy. A new bullish bar prints on the chart. Yes, my bullish proposition is right (does not notice that the bullish bar has a small range). A bearish bar appears, yes, this bar lacks momentum. The market is still bullish (does not notice that although it had a small range, it has a wider range than the preceding bearish bar). Because we are looking for confirmation, we lose sight of what the market is showing us. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: When you think that everything is confirming your market view, think again. In practice, look for reasons against taking a trade and not for it. When in doubt, ask yourself what kind of market development or price action might negate your view? If you cannot answer this question, you are affected by confirmation bias.

5. 3. Gamblers fallacy MEANING: The gambler's fallacy is the mistaken belief that, if something happens more frequently than normal during some period, it will happen less frequently in the future, or that, if something happens less frequently than normal during some period, it will happen more frequently in the future. In situations where what is being observed is truly random. This belief, though appealing to the human mind, is false. This fallacy can arise in many practical situations although it is most strongly associated with gambling where such mistakes are common among players. EXAMPLE: If market or any stock has given good up move in last 5 consecutive days then we think today market will fall as it is rising from last 5 days so we should not buy today in fact we should sell today. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Even if market is rising from last many days have guts to trade in buy even today, if your trading system says you to buy and vice versa.

6. 4. Ownership bias/endowment effect MEANING: In psychology and behavioral economics, the endowment effect is the hypothesis that people ascribe more value to things merely because they own them. According to the old adage, "A bird in the hand is worth two in the bush." It does not matter if the object in question was purchased or received as a gift, the effect still holds. EXAMPLE: An individual may have obtained a stock, at the time, was of relatively low cost. If an offer were made at a later date to sell that stock for multiples of the original price, the endowment effect might compel the stock owner to refuse offer, even if he gets irrational premium. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Investor must always know where he has to exit, if the stock is overvalued then he must exit that counter. A stocks worth should not be done just by thinking I am his owner. Valuation should be done on impartial basis.

7. 5. Herd Mentality/ bandwagon bias MEANING: Herd instinct is a mentality characterized by individual decision-making thoughtfulness, causing people to think and act in the same way as the majority of those around them. We do things because everyone else seems to be doing it, even when there are no good reasons for doing so. A herd mentality relates to instances in which individuals descend to the same or similar investments, based almost solely on the fact that many others are investing in those stocks. The fear of regret of missing out on a good investment is often a driving force behind herd mentality. EXAMPLE: a lack of or Warren Buffett’s famous advice to be greedy when others are fearful and fearful when others are greedy is a slur of this bias. You heard everyone saying that the bull market will stop soon. The news, gurus, and forums are all bursting with negativity. You looked at your charts with your technical analysis tools and found nothing bearish. You looked at more charts and found some bullish clues. But because everyone was saying that the bull market would come to an end, you sold all your long positions. The outcome of the market does not matter, whether it continued to rise or fall. You have already surrendered to the bandwagon bias because you follow the herd instead of your analysis. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: The best traders are often lonely, because they listen to their own analysis, and ignore the voices of the masses. You might think that to avoid the bandwagon, you must adopt a contrarian mindset and always go against the herd. That is not the case. The masses might be right, or they might be wrong. But you are probably wrong when you think that something is right only because everyone seems to say so. Never read market commentaries or listen to market news when you trade.

8. 6. ANCHORING BIAS MEANING: This cognitive bias refers to giving too much weight to the anchor (first piece of information) when we make decisions. As traders using technical analysis, who or what offers us the most information? The market, of course, the market keeps offering us new information. Every price tick that comes in represents fresh information, we need to analyze new data. EXAMPLE For instance, a trading session started off with a powerful bullish thrust. You were convinced that the session would be a bullish trend day. Essentially, you were anchored to the information glimpsed from the “strong bullish thrust.” Although the market showed clear signs of exhaustion, you maintained that it was bullish. As the session ended, you realized that you spent the day and your trading capital fighting the market. The fact is you were anchored by the first bullish thrust. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Don’t be stubborn in Market; recognize what the market is telling you now. Actually strike a balance, as Technical analysis requires us to look back in time for support and resistance to frame the current market. In this sense, it compels us to be anchored to past information. Yet, we need to look at new observations continuously to follow the market flow. To keep up this delicate balancing act, analyze historical data, but do not hold on to past conclusions.

9. 7. RECENCY BIAS MEANING: Our brains naturally put more weight on recent experience. EXAMPLE In the market, this cognitive bias can manifest in over-learning from recent losses. We are more affected by recent losses. Thus, in trying to improve our trading results, we avoid trades that remind us of our recent losses. For instance, you lost money in three recent pullback trades in a healthy trend. Hence, you concluded that pullback trading in a strong trend is a losing strategy. Then, you switched to trading range break-outs. Due to your recent experience, you overlooked that most of your past profits came from pullback trades. By turning to trading range break-outs, you could be giving up a valuable edge in your trading style. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Don’t learn from recent experience. Learn from your trading results over a more extended period. Reviewing your trades and learning from them is crucial. However, in practice, we should not examine them and draw conclusions too often. We should make sure that we have a larger sample of trades across a longer period, before arriving at useful conclusions.

10. 8. Overconfidence bias MEANING: The overconfidence effect is a well- established bias in which a person's subjective confidence in his or her judgments is reliably greater than the objective accuracy of those judgments, especially when confidence is relatively high. Overconfidence can be harmful to an investor’s ability to pick stocks over the long term. EXAMPLE: If a person has bought a stock and it goes up after that, then the person might get overconfident about his stock-picking abilities and may invest in a stock without proper research. A Volatility, Price, and Profit When All Traders Are above Average,” written by researcher Terrence Odean, illustrates this. The study found that overconfident investors typically conducted more trades as compared with their less- confident counterparts. Perhaps unsurprisingly, overconfident investors believed that they were better than others at picking the best stocks and times to enter or exit a position. Odean also found conducting the most trades tended, on average, to actually receive yields significantly lower than the market. 1998 study entitled “Volume, TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: To avoid overconfidence, it can be useful to remember that even professional fund managers and traders with access to the best reports and computational models still struggle to achieve market-beating returns. Those fund managers who maintain realistic estimations of themselves and their abilities know that every investment day offers a new set of challenges and that no investment technique is perfect. Indeed, most overconfident investors are only a trade away from a very humbling wake-up call. Overconfidence bias happens when an individual has overestimated his prediction abilities and his data precision. When overconfident he misjudges his belief. This might, in turn, lead him to face situations for which he is not prepared enough. that traders

11. 9. ATTRIBUTION BIAS MEANING: When things go well, it is because of me. When things go south, it is definitely not me. EXAMPLE: After a fantastic trade with a nice profit, you start to feel like a genius, thinking that your trading skills made it possible. After a losing trade, you blame your broker, your computer, and your chair. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Take credit for the right things. Take credit for following your rules, and not for your profitable trades. Take credit for your consistent profits over a large sample, and not for a single profitable trade. Assume responsibility for everything, including your losses. As an independent trader, you do not shift blame because it does not help you progress. Take responsibility to find out what went wrong and doing what is needed to improve.

12. 10. ILLUSION OF CONTROL MEANING: This cognitive bias believe that we can influence something over which we have absolutely no control. EXAMPLE: You think that you can control if you keep seeing stock’s price its price keeps rising so you decide to see that stock price in screen for whole day after buying it, which is such a stupid thought but still you think it. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: The illusion of control is hugely relevant to traders. We work in uncertainty; do not seek certainty and control. Seek to be comfortable in uncertain situations beyond our control. Recognizing that we have no control over the market is the first step towards managing our risk. Hence, focus on controlling what we can control, our actions and emotions. Focus on your discipline, because our mind is the only thing we can ever dream of controlling.

13. 11. HINDSIGHT BIAS MEANING: “Yes, I knew it all along.” (No, you don’t). The hindsight bias affects a person’s ability to learn from experience as it hinders the ability to look back on past decisions and learn from mistakes. EXAMPLE: You looked at a historical chart and started explaining the chart patterns that led to the bull market. You sound like you were making sense. You convinced yourself that you were making sense, and you would catch the next bull market. When the next bull market came, you didn’t even notice. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: The hindsight bias is difficult to overcome. Our best shot at it is to keep excellent records of our trading activities.

14. 12. Negativity Bias MEANING: The negativity bias refers to the notion that, even when of equal intensity, things of a more negative nature (e.g. unpleasant thoughts, emotions, or social interactions; harmful/traumatic events) have a greater effect on one's psychological state and processes than neutral or positive things. EXAMPLE: The bull market is alive and well, yet many investors have missed the rally because of the fear that it will reverse course. Negativity bias causes investors to put more weight on bad news than on good. Some might call this risk management, but this bias can cause the effects of risk to hold more weight than the possibility of reward. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: The human brain is wired for negativity, negativity is natural state so it’s easy to find fault. Always remember opportunity favors positive mind. It’s hard to make money at trading with a permanent negative mindset as you see fewer opportunities.

15. 13. Sunk Cost Fallacy MEANING: Sunk cost fallacy is behavior when someone continues to do something even if it doesn’t provide a favorable output just because they have already invested huge time and resources on it. A sunk cost is a cost that has already been incurred and thus cannot be recovered now, in an effort to recover it we end up spending more money, time and energy. This behavior of committing more money, time or effort to our earlier decisions is called sunk cost Fallacy. Sun cost fallacy is not only about money spent, it is also about time and effort spent on something. EXAMPLE: When people buy shares of a company and suppose company starts doing bad and share price falls then either investor’s start buying more shares of that company with idea to recover earlier invested money or they don’t invest new funds but also don’t sell existing shares just with a mindset that already they have invested good amount of money and time in this company so will wait for the share price to reach to their purchase price. Here when company is really not doing good then there is no logic to buy more shares or to wait for share price to rise and reach their purchase price because money which is already invested is gone and whatever loss they are incurring now is a sunk cost. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: Logically if as an investor if you had not invested in this company earlier and you were analyzing it for the first time to invest then will you invest in it? The answer is NO. Then why you want to stick to this company just because of sunk cost fallacy. Ideally, if any other company is available with good future prospects then one should sell these share, book loses and move there. But more the share price will fall more the investors will stick to it. Both these decisions are not taken rationally but due to sunk cost fallacy.

16. 14. BIAS BLIND SPOT MEANING: You see that other people are biased, but do not realize your own cognitive biases. EXAMPLE: After reading an article on cognitive biases (like this one you are reading now), you watched your friend’s trade. In your mind, you thought that he was wrong to do this. That’s the loss-aversion bias. Oh, he was biased again in exiting the market. The chances are that when you review your own trading decisions, you will find fewer biased decisions. This is not because you are not biased but because you are affected by the bias blind spot. TRADING/INVESTING RULE TO SHIELD FROM THIS BIAS: To find your own cognitive biases, get someone else’s opinions. We all have blind spots when we look at ourselves. I am ending with this cognitive bias to remind you to think beyond this article. And to remind myself that although I can point out cognitive biases of others, I might not be aware of my own biases.

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