Committing to the simple activity of witnessing decision making preferences and cognitive biases will result in improved decision making capabilities and will lead to more satisfying investment experiences.
Hamilton, Canada (PRWEB) May 16, 2012
Investment Analysis Technology Company Verdant Analysis endorses the development of strong meta-decision making skills as an essential step to achieving investment adeptness. Decision making is at the heart of investing: when to buy, when to sell, what to invest in. To answer these questions, investors will explore techniques such as market timing, technical and fundamental analysis, but rarely do they spend time thinking about how they decide. Meta-decision making, in other words. And this may be more important than the particular investment style.
Investing offers a good opportunity for developing transferable meta-decision making skills. The environment is noisy, subject to periodic shocks and therefore challenging. At the same time, it is also possible to quantify results. An investor can calculate their return on individual stock picks or their whole portfolio and they can also measure their abnormal return using the Verdant Analysis alpha calculator.
Taking up the challenge of improving meta-decision making skills can improve both investment results and potentially improve decision making in other areas of life as well.
The first step, basic to any endeavor of inquiry, is awareness and observation; becoming awake to how one makes decisions. The spectrum runs from analytical to intuitive and both skills are valuable. Both can be enhanced and developed and each has their place in decision making.
The next step is to understanding one’s own personal cognitive biases. These are idiosyncrasies that interfere with rational thought. Some examples commonly found in the world of investing include overconfidence - thinking that we’re more clever or more prognostic than we are and the sunk cost effect – which can manifest in the inability to get out of a losing position while waiting for it to turn around.
(As an aside, Dr. John Coates has a fascinating new take on a whole other area that may be driving irrationality - hormones. His book, The Hour Between Dog and Wolf, posits that increased testosterone levels go hand in hand with high flying, euphoric risk taking and blazing bull markets. As risk increases, cortisol, the stress hormone escalates. Eventually, there is more collective cortisol than testosterone and the market crashes).
Understanding cognitive biases makes it possible to protect one’s blind spots.
Here’s an example: an analyst can be very impartial when evaluating the merits of a security. However, they may lose a lot of that objectivity once they make a commitment. As a result it may be a lot more difficult to exit a position than to enter it.
A real world example is an analysis that took place on the Canadian oil and gas sector a few months ago. The analyst went long a security but then soon discovered that one of the key metrics, a theoretical stock price, was faulty owing to one piece of bad data.
This theoretical price was an important factor. In Ben Graham parlance, it was the Margin of Safety and the analyst followed a rule that the actual stock price must trade at a discount to the theoretical price.
Upon discovering that the stock was actually selling at a relative premium, the correct line of action was to objectively re-evaluate and exit. But the emotional commitment that was created by taking a position was stronger.
Without the willingness to observe, this lesson might have been lost. Committing to the simple activity of witnessing decision making preferences and cognitive biases will result in improved decision making capabilities and will lead to more satisfying investment experiences.
About Verdant Analysis
Verdant Analysis, Inc. develops investment analysis technology that improves the speed and quality of financial decision making. Our powerful and intuitive applications are designed to meet the needs (including custom design needs) of investors performing robust analysis. The data infrastructure upon which the applications reside includes market and financial statement information, with new material coming soon.