Caption: Chart showing growth (geralt/Pixabay)
I’m a self-employed investor. My job involves technically analyzing the price history of a given stock, deciding if I should buy it, and when I should buy it. Once I have made a purchase I must already have planned the entire investment. At this point in my process, I have made a prediction on where the price of this stock is likely to go based on mathematics. If I predict a rise in the price 2 months from now, I can’t abandon my plan if the price goes lower tomorrow. Day-to-day changes alone mean practically nothing in the vast majority of long-term predictions.
Making trades based on mathematics means ignoring emotions. If I have made an investment plan that is mathematically and therefore logically likely to work, then making any changes to it based on fear or greed will result in lowering my chances of being successful. I once lost $700 dollars on a small short-term trade because I sold an ETF too early out of fear. My prediction ended up being correct and I would have made money had I not succumbed to my primal fears. In contrast I’ve made money countless times while following a mathematical prediction, and many of these times I felt certain that the math was wrong once fear set in. It always amazed me that even though I know facts and logic are more important than how I feel when it comes to financial decisions, my emotions still seem to invade my decision making.
In many instances in life the objective truth of a situation can be very counterintuitive. People unknowingly use logical fallacies to make decisions everyday and investing will teach you this the hard way. However, there are easier ways to understand these fallacies we all commit. One very important fallacy to avoid making when investing is the conjunction fallacy. My favorite example of this is a thought experiment created by Tversky and Kahneman in 1983. Here it is:
Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which is more probable?
• Linda is a bank teller.
• Linda is a bank teller and is active in the feminist movement.
The correct answer is option 1. Statistically speaking, it is more likely that Linda falls into one category (bank teller) than two categories at once (being a bank teller and a feminist). Regardless of this solid logic, 80 percent of participants chose option 2. Even expert statisticians committed this fallacy and chose option 2. Even if we know that option 1 is more probable statistically, we are tempted to pick option 2 because we feel that Linda is a feminist based on her college experience. Instead of going with the safe and logically sound answer that Linda is a bank teller, we are tempted to gamble on the fact that she is both a bank teller and feminist at the same time.
The conjunction fallacy is very dangerous when investing because people will see a stock price move up or down over a week and make long term predictions on where the price will go in the future. Let’s pretend a stock drops a percent or two over the course of a week, they’ll say, “looks like it’s doing bad, I’m not going to invest.” In reality, a week of stock price data is not a large enough sample size to predict what a stock will do over the course of a year or even just a few months. There are too many examples that could be put into this blog for me to list them all. What is important to know is that this fallacy can take hold of your financial decision making based on any correlations you see.
Beyond the monetary value of checking facts, I know how information is crucial to our democracy and that being a part of this society means staying informed. Many dictatorships have started with one or more groups spreading misinformation to insufficiently educated citizens who failed to use rational thinking to determine that these ideas were false.
Like the foolish investors who went with their gut reactions instead of reason, these citizens “bought” worthless falsehoods that appealed to their fear or greed, and “sold” their political support to manipulative politicians. In stock trading, when investors make mistakes about financial facts and go with their gut instead of their reason, only they suffer. Unfortunately, when citizens make mistakes about the political facts and go with their guts, we all suffer.
I don’t want that fate for my society, and neither should any businessman who knows the importance of going with their head over their gut. Because of my professional background, when I heard about the Pro-Truth Pledge project, I took the pledge. Taking the pledge is commiting to fact-check information before you share it, defend others when they share true information (even if you disagree with them), and challenge information that is false. Taking it is sending a signal to all that you care about the facts and don’t want our society to be ruled by manipulative politicians who sell falsehoods.
Now, I call on all who understand the value of believing the facts and not going with your gut even when tempted to do so to go to ProTruthPledge.org, take the pledge, and implement it in all areas of life. Losing money based on illogical thinking is bad enough, losing our entire society to it is even worse.
Bio: Michael DeCandia is the founder, CEO, and CFO of TFIC (The Future Investment Company). He has been an investor and a skeptic for over a decade and volunteers his time to spread rational thinking.