Introduction
Jeff's audience is large but still pretty exclusive. He writes for an intelligent group of individual investors and also for colleagues in the advisory business. In their regular lives, a bit of reading and study takes them a long way toward solving life's problems.
Something quite different happens in the investment world. The individual investor is faced with so much information that it is like a fire hose with no regulator. Most sources are paid for viewer ratings or page views. Fear sells.
A successful investor needs to put aside the scare stories and stick with the facts. It also requires perspective on international issues, economics, and public policy. For many it would make more sense to turn the job over to an expert and enjoy life. (see the great commentary from Josh Brown). “If you had five years…..”
Individual Investor Quicktip – 1/10/15
Each week, we highlight a past post from “A Dash” with particular relevance to current events. As the start of every year seems to be accompanied by some sort of trader adage, we'd like to start off by tackling heuristics.
There is a strong tendency among individual investors to rely on bits of conventional wisdom – or heuristics – as a way to explain market moves. This is problematic by definition! If your investment approach is based on common knowledge, it doesn't provide you with any edge. This was a theme of one of the first ever posts on A Dash of Insight.
Experts in fields requiring decision-making know all of the heuristics, but they also know the underlying causal models. They know when to make exceptions. They know when to say “Things are different this time.”
In one of my worlds, high-level tournament bridge, many of the competitors are experts at stocks, options, and other derivatives. They are highly skilled at analyzing risk and reward, doing so quickly, and acting under pressure. Bridge has a large number of heuristics that help beginning players learn how to play at an adequate level, avoiding serious error. There is a point count system for evaluating hands. There are rules of play like “second hand low,” “third hand high,” lead up to weakness,” and “cover an honor with an honor.”
Blindly following these rules might help a player achieve average in a Flight C game, but that is about it. Experts understand that these rules usually work, but each case is tested to see if “this time is different.” When you see a hand in a bridge column, the expert player popped an honor second hand, or ducked as third hand, or whatever.
Perhaps readers can suggest similar concepts from other intellectual activities requiring heuristics.
The point is that knowing the basic rules of the stock market like The Presidential Cycle, Don't Fight the Fed, Three Steps and a Stumble, or other similar slogans is only enough to make you average in the Flight C game. These are universally known market concepts that should be fully discounted by current market prices.
