My experience in the stock market has been close to 13 years. These years have been spent in many capacities: as an investor, trader, broker, money manager and analyst. I have had my fair share regrets and happiness in the markets. I learned a lot and continue to learn. It's not always about the outcome of trades you have taken up. You can feel happy when you make profits and you may regret losing. You can feel these emotions even if you don't take up trades. Let me share one of my greatest regrets about the stock market.
In recent years, August/September 2013 was a great time to start a long-term portfolio. Throwaway valuations were possible on stocks of outstanding businesses. This was a situation I was able to see and was able to address while I was busy structuring my equity portfolio. It was difficult to choose stocks for my portfolio. It was difficult because there were so many options. This is exactly what a bear markets does to you: it makes you want more options.
While I kept a few stocks in my portfolio, I decided to let go of many others such as MRF, Bajaj Finserve, and Bajaj Finserve. These stocks were removed because I found investing in other stocks attractive. Stocks such as MRF and Bajaj Finserve performed spectacularly, but I don't regret making that decision.
But, I am not regretful for my decision to invest in Sundaram Clayton Limited.
This chart will help you to understand the importance of a good relationship.
I did my stock research and concluded that the stock was a good buy. I have circled the area where I want to buy, which is roughly around 270 for each stock. It was a bear market so I was pretty rigid about the price I wanted to pay - around 270.
Although the stock price increased slightly to around 280, I didn't change my mind. I waited. The stock price rose to 290 and I waited. The stock price shot up to 310 a few days later. I recall convincing myself that the stock would retrace to 270 since it was a bear stock market. Even though I didn't want to pay 15% for a 'premium,' I still felt it was a fair price.
As you might have guessed from the above, 270 was never achieved and I did not get to purchase this stock. Here is what actually happened to the stock.
For your reference, I have circled the 270 mark once more. This is where my so-called "price conflict" occurred.
My mind played a lot of games with me, and I may have missed one of the best investment opportunities in my entire life. A well-known trading bias known as 'The Anchoring Bias,' is what prevented me from purchasing Sundaram Clayton.
When I searched Wikipedia for "Anchoring Bias", I found a new term - it's also known as "Focalism". Anchoring bias is one of several biases that are grouped under the heading 'Cognitive Biases. Cognitive bias refers to a systematic error in thinking that can affect the way humans make decisions and make judgments. The list of cognitive biases includes Anchoring Bias.
Anchoring Bias can cause us to become fixated on the first level information that we see. In my own case, for example, I was fixated to the first price that I saw on the terminal: 270 (for Sundaram Clayton). This price anchor was 270.
Consider your trading situation. How many times have you missed placing a buy order or stop loss order due to the price you believed was 'right'? Only to find out later that the stock performed exactly as you expected. In most cases, the price difference between what is right and what is available on the market would be minimal - perhaps a few Rupees, but our minds are not able to allow us to move forward.
Anchoring bias is just like other biases. There is no cure. It is important to recognize it and to use critical thinking to approach markets.
Another cognitive bias is this - even though you won't find much about it in the trading world. It does have an impact on traders who trade derivatives, however.
Let me first give you an overview of "functional fixedness" bias, and then I will relate it to the trading industry.
A juice shop is located near my office, which I visit for fresh juice. One of those visits was when I asked for regular orange juice. However, the guy at the juice store was busy fixing the mixer. The handle on the jar was too loose so it had to be fixed. He was trying to locate a screwdriver that would tighten the handle of the mixer. He couldn't find one and was unsure how to proceed.
His colleague also walked in at the same time and discovered the problem. He just grabbed a spoon from the trash and used the flat end of the spoon as a screwdriver to tighten the jar. Juice was then served.
Functional fixedness at its finest. Functional Fixedness refers to a cognitive bias that restricts a person's ability to use an object in the same way that it was used previously. We assign tasks and live with this rigidity throughout our lives. We have been taught that a screwdriver is all you need to tighten screws. A spoon, however, can accomplish the same task. To solve problems in unusual ways, one must think outside the box.
Functional Fixedness is not a limitation to our thinking in trading. Let me begin with a classic example.
Let's say you have Rs.100,000. You've identified Nifty as a good trading opportunity and plan to keep the trade open for at least the next two or three days. You must choose a NRML product type because you plan to keep this trade open overnight. This trade is typically blocked at a margin of Rs.65,000/-.
You would take the trade at 3:20 pm and move the position forward. End of the day, 65K would be considered margin. 45K would represent your balance. This can be used to fund another trade the following day.
Nifty moves in the direction you want it to when the next market opens. You are satisfied with how things are turning out.
Let's say you spot an excellent intraday opportunity in TCS stock futures. This requires you to pay a MIS margin of 60K. What should you do? You'd need to make a decision. You cannot trade the TCS intraday.
This is where functional fixedness plays the role. The NRML (margins for overnight positions) is what we consider'margins block'. We forget about it until we are able to square off the position.
We can actually keep the overnight position and also take advantage of the intraday opportunities if we think outside the box.
This is how it would look:
Take a look below at Tata Motor's.
This chart has a few key points that I have highlighted.
Given the above, you can assume that the stock is ready for an up-move.
This analysis aside, how do you see the news that made headlines today?
You will likely view this news article as a trigger for Tata Motors's price to edge higher, and thus support your logic of purchasing the stock. The fundamental news might not be enough to push the stock price higher in reality. The subconscious mind then starts looking for information that supports your view. In other words, your trading opinion is formed by only looking at and assimilating information that supports it. Your brain is unable to recognize information that doesn't support your original contention.
This is known as the "Confirmation Bias".
To overcome confirmation bias, critical reasoning is key. It is important to ask yourself: "So what?"
This one is hilarious.
Have you ever won a trade and felt proud of your analysis? You might have bought an option that gained 100% on the premium, or you may have bought stock that appreciated multifold.
You should give yourself a pat on the back every time you make a profit. What about when you lose? What can you do?
I have been in stockbroking and can tell you that when someone loses money, they always blame the broker. Brokers are blamed for many things by traders, including charts not loading properly, slow orders, and other issues.
Every thing can be attributed to another person's error (primarily the broker), and not the subpar analysis.
This is known as the "Attribution bias" and many people fall prey to it because they don't recognize the error. You can overcome this bias by keeping a trading journal. Make entries that explain why you entered into trades and why you closed them. You can gain valuable insight into your trading behavior by keeping a journal.
These biases are endless. It would be impossible to include all of them. Here's what I'll do: I'll keep the chapter open and add biases as I find them.
This chapter will close the module on Risk and Trading Psychology. As always, I hope that you enjoyed this module as much as I enjoyed writing.
Please keep those comments coming!