Tuesday, 18 August 2009

Taxi Driver Syndrome

The relationship between psychology and investing (gambling) is a fascinating subject and an interesting post on the Betfair forum today (from aye robot), got me thinking. He posted this little nuggett on 'gain theory':

The theory suggests (and it's shown in experiments too) that when people make losses they tend to be much more aggressive and reckless in trying to recover those losses than they would be if they were winning. By contrast when people are winning they tend to become more conservative to retain their winnings. This doesn't only apply to gamblers- taxi drivers for example tend to work longer on days when they're not getting many fares and clock of early if they've done well when doing the opposite would be more logical.
Whilst I am by no means immune to the negative psychological effects of a big loss, I am at least now able to recognise this state, and act accordingly - which is to say, I turn the computer off and forget about investing until I have dealt with the loss. Incidentally, how long this process takes depends more on the reason for the loss than the amount. If I lose a bet that was value, I'm OK with it, even if the amount is four figures. On the other hand if I lose a bet that was ill-considered, then I am not so relaxed about it, even if the amount is less.

How about days when I'm winning? Do I become more conservative to retain my winnings? On this, I'm not so sure. I am sure that I never walk away when things are going well, and I don't believe in daily targets. Some days there may be no value opportunities, on others there may be several, and to shut down solely because you have achieved an arbitrary profit makes no sense. "Make hay while the sun shines" makes a lot more sense.

Here are a few psychological observations relating to investing or gambling from the www.investorhome.com site, some of which are very interesting and you can see how they relate to exchange betting trading:

"People typically give too much weight to recent experience and extrapolate recent trends that are at odds with long-run averages and statistical odds. They tend to become more optimistic when the market goes up and more pessimistic when the market goes down. Many believe that when high percentages of participants become overly optimistic or pessimistic about the future, it is a signal that the opposite scenario will occur."

"People often see order where it does not exist and interpret accidental success to be the result of skill. One of the most cited examples is Amos Tversky and Thomas Gilovich's proof that a basketball player with a "hot hand" was no more likely to make his next shot than at any other time. Many people have a hard time accepting some facts despite mathematical proof."

"People are overconfident in their own abilities, and investors and analysts are particularly overconfident in areas where they have some knowledge. However, increasing levels of confidence frequently show no correlation with greater success. For instance, studies show that men consistently overestimate their own abilities in many areas including athletic skills, abilities as a leader, and ability to get along with others. Money managers, advisors, and investors are consistently overconfident in their ability to outperform the market, however, most fail to do so. Gur Huberman of Columbia University recently found that investors strongly favor investing in local companies that they are familiar with. Specifically investors are far more likely to own their local regional Bell company than the other regional Bells. The study provides evidence that investors prefer local or familiar stocks even though there may be no rational reason to prefer the local stock over other comparable stocks with which the investor is unfamiliar."

"People often see other people's decisions as the result of disposition but they see their own choices as rational. Investors frequently trade on information they believe to be superior and relevant, when in fact it is not and is fully discounted by the market. This results in frequent trading and consistently high volumes in financial markets that many researchers find puzzling. On one side of each speculative trade is a participant who believes he or she has superior information and on the other side is another participant who believes his/her information is superior. Yet they can't both be right."

"Many researchers theorize that the tendency to gamble and assume unnecessary risks is a basic human trait. Entertainment and ego appear to be some of the motivations for people's tendency to speculate. People also tend to remember successes, but not their failures, thereby unjustifiably increasing their confidence. As John Allen Paulos states in his book Innumeracy, 'There is a strong general tendency to filter out the bad and the failed and to focus on the good and the successful.'"

"People's decisions are often affected by how problems are 'framed' and by irrelevant but comparable options. In one frequently cited example, an individual is offered a set amount of cash or a Cross pen, in which case most choose the cash. However, if offered the pen, the cash, or an inferior pen, more will choose the Cross pen. Sales professionals typically attempt to capitalize on this behavior by offering an inferior option simply to make the primary option appear more attractive."

And finally, a couple of quotes that if you are serious about trading, you should pay heed to. Well, the first one anyway:
"Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear" - William Gross
"Only two things are infinite, the universe and human stupidity, and I'm not sure about the former" - Albert Einstein

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