How the Art of Thinking Clearly Can Help Us in Investing: Part 2
This is the second part of a series featuring investors’ behavioural traits and tendencies.
You can refer to Part 1 HERE.
These traits are taken from the famous book “The Art Of Thinking Clearly” by Rolf Dobelli.
Let’s look at another three psychological phenomena and how we can stay alert to their effects.
3. Authority bias
When someone claims to be an “expert”, it can have an unfortunate side effect: we let our guard down.
This behaviour has also been observed in another famous book “Influence” by Robert Cialdini.
When investing, we constantly see talking heads appear on investment news media channels proclaiming that they know if a recession is coming, or if a stock is going to rise or fall the next day.
These false prophets claim to be “experts” and are supposedly the leading authority on the topics which they speak about.
However, be mindful of two important facts.
Such people usually have a vested interest in what they tout, implying that you should discount at least half of what they claim.
Secondly, even if the person is truly an expert in investing, we need to remain sceptical and continue to rely on our analysis and judgement.
After all, no one cares more about your money than you do.
4. “It’ll get worse before it gets better” fallacy
The statement above illustrates a common fallacy in the way we think about situations.
When things go downhill, the human mind finds it tough to accept reality as it is generally optimistic.
Investments do blow up from time to time no matter how well we have analysed and mitigated our risks.
It is an inescapable fact that no one gets it right 100% of the time, not even famed investor Warren Buffett.
Being wrong at times is something investors have to deal with, whether they like it or not.
There will be instances when a bad situation just carries on worsening without any recovery in sight.
If we buy into this fallacy that things will “always” get better, we end up holding on to our losers without facing up to the harsh reality.
For investments that face a bleak future, the correct action would be to cut your losses and move on to a more promising candidate, rather than holding out hope for a lost cause.
5. Regression to the mean
Regression to the mean describes a statistical phenomenon in which each subsequent measurement of data points tends towards the average of the data set.
An example is when the growth of a company within an industry far exceeds the industry’s average growth rate over a boom-and-bust cycle.
According to regression to the mean, there is a high probability that growth will start to slow in subsequent quarters for the company.
The slowdown will carry on till its average growth rate trends towards the long-term growth rate of the industry in which it is.
Investors have to be aware of this tendency and adjust their expectations accordingly.
This is especially relevant if you witness sharply-higher growth rates in certain companies.
A recent example to refer to is the glove companies such as Top Glove Corporation Berhad (SGX: BVA) and UG Healthcare Corporation (SGX: 8K7).
The pandemic created a sharp and sudden demand for nitrile healthcare gloves, causing UG Healthcare’s share price to surge from just S$0.06 in March 2020 to a high of S$1.09 in October of the same year.
Similarly, Top Glove saw its share price race from S$0.667 in March to hit a high of S$3.10 in October.
As demand for gloves waned with the virus becoming endemic, both companies also saw their revenue fall off a cliff.
UG Healthcare and Top Glove are now trading at S$0.18 and S$0.23, respectively, a far cry from their October 2020 highs.
Regression (or some people use the word “reversion”) to the mean usually results in significantly lowered expectations which may result in a sharp share price adjustment once people factor in the reality of the situation (that rapid growth may not be sustainable).
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Disclosure: Royston Yang does not own any of the companies mentioned.
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