Behavioral Finance

Are You Really In Control Of Your Stock Investing?

Are we really in control of our stock investing decisions? Or are we led to believe that we are in control? You have a decision to change your behaviour or leave it to chance.

When it comes to how your brain processes information and makes decisions, we have two systems that facilitate it.

Psychologists have termed these two systems as the X system and the C system. X system is ingrained within us, almost like a reflex. Whereas, C system is the rational and longer taking decision maker.

It is learning how to control these behaviours that will allow you to regain control of your stock investing decisions.

Warren Buffett has often said that investors need to control their emotions. That success in investing does not relate to high IQ once you have gone above the level of 100.

An investor with ordinary intelligence needs the temperament to control urges that gets people into trouble when investing.

That is because we are emotional creatures, and we react first and think second. A famous quote by Mike Tyson says it all, “Everyone has a plan until they get hit in the mouth.”

Know what you buy and why you bought it.

You are your own enemy.

Fighting For Control In Stock Investing

X system is the default option that runs throughout our day-to-day. It is automatic and effortless, and allows your brain to effortlessly process information.

Similarly this system activates when we are faced with undeniably difficult problems. Think of it as a fight-or-flight response.

Now Imagine a snake striking at your face behind a glass box. X system does the processing, and automatically you react by jerking back out of harms way.

If you had let C system do the processing, you wouldn’t have needed to move. Because the snake is in glass box. You were always out of harms way.

X system tend to manifest when problems are either too complex, ill-structured or ambiguous. In other words, when it causes the person significant stress or when the stakes are high.

It is your gut feeling.

Have you ever noticed your mind react to a falling stock price or rising stock price. Even though there is no new available news.

What was your decision during such a moment in time? Were you inclined to follow the crowd by selling as to not lose more money. Or buy so you don’t miss out on the gains?

Have you been so caught up in your emotions that you forgot that doing nothing was also a suitable decision?

I have been guilty of all those in the beginning of my stock investing journey. But it is not impossible to train your mind into slowing down and making better assessments.

It takes time and hours of learning to be able to think rationally. Forming good investing habits takes some work but a worthwhile task.

Over-riding The Two Systems

A Yale professor by the name of Shane Frederick designed 3 questions that test how easy it is to override our X system.

These questions boast to be more powerful than any IQ test or SAT score (American standardized test) at measuring the two system outputs.

The 3 questions are known as the Cognitive Reflection Test (CRT). Below are the test questions, let’s see how many you can get right:

  1. A bat and ball cost $1.10 together. If the bat is a $1 more than the ball, how much does the ball cost?
  2. If it takes 5 minutes for 5 machines to make 5 widgets. How many minutes will it take 100 machines to make 100 widgets?
  3. In a lake there is a patch of lily pads that double in size everyday. If it takes 48 days for the patch to cover the entire lake, how long does it take to cover half the lake?

If these problems seemed complicated to you don’t beat yourself up – you are not alone. Upon giving this test to 3,500 people, Frederick found that only 17% were able to get all the questions right. While 33 % got none right.

Each of these question have a undoubtedly obvious but unfortunately incorrect answer. Vice versa, a less than obvious correct answer.

Were your answers:

A.

  1. $1
  2. 1 minute
  3. 24 days

Or

B.

  1. $0.05
  2. 5 minutes
  3. 47 days

When the underlying problems are too difficult we tend to go with our gut which will lead to answers in A. Where as B. took some thought processing to get to the answer.

The questions themselves are not difficult. But under a test condition and a time-restriction to complete the questions, pressure will overcome you or you can overcome pressure.

When it comes to stock investing, do you allow the constant market volatility to steer your decision making?

Take Control of Your Stock Investing

The best time to buy a stock is when market participants is in a full state of pessimism. And the best time to sell a stock is in a time of maximum optimism.

Few people would disagree with this sentiment.

However, when everybody is busy in capitulation it can be hard to stand against the tide and buy. You can’t help to think, ‘what does everybody else know that I don’t?‘.

Truth be told, they do not know anymore than you do. But when enough people do something, there is a herd mentality.

Think about a public space. A person stares into the sky, no one pays much attention. Ten people stare into the sky, people become curious but walk past. A hundred people stare into the sky, now everybody looks up.

What’s in the sky? A bird, a plane? Most likely nothing, this scenario was made up but it tells a narrative.

The stock market is there to serve you not direct you. It is your decision to buy at an attractive price or refuse at an obscene price.

If you let X system do the thinking for you, you are more likely to regret the decisions after.

Being an intelligent investor requires work and time. You can either spend time following market sentiment and the volatility. Or you can spend the time reading and analysing businesses, dissecting financial statements, and valuing a stocks intrinsic value.

If you know what you buy and why you bought it, you are less likely to act impulsively.

Doing the research and building your investing knowledge can help you effectively utilise C system to make more informed decisions.

Takeaways

  • Stock investing is 10% doing and 90% waiting.
  • Train your mind to slow down, instead of reacting immediately. Sometimes the best course of action is doing nothing.
  • Know what you buy and why you bought it. You can borrow an idea but not the conviction.

Incognito Wealth – Investing Tools

Need help with investing in the stock market or personal finance? Visit my Etsy store for digital excel templates. Simplifying finance so that everybody can reach financial independence.

Incognito Wealth - Financial Independence One Investment at a Time