Dangerous traps to be avoided

Temptation from friends, office colleague or neighbors

“Hey bro, today I made 10,000 from the stock market”! You may find similar kind of statement from your friends or office colleague or neighbors. During bull market, such comments are quite common. The fact is that your friend won’t share the incident when he lost 10,000 from stocks. It gives us immense pleasure in sharing our achievements. On the contrary, sharing failure is shameful and hard.

Similarly in the stock market, it is a matter of immense pride to “earn 10,000”. Sharing such statement gives us much more delight than to earn it. On the other hand, nobody wants to share or accept his failure.

So, a statement like “I made 10,000” is just a single part of the story. Don’t jump into the stock market just because of such “partial information”. Don’t get excited with your friend’s success story. Don’t follow stock recommendations based on such stories over social media (Facebook, Whatsapp etc)


Temptation from your broker –

Your broker will offer reduced brokerage for frequent trading or large volume trading and is always ready to offer high margin money for trading. They may try to convince by saying “You have 20,000 in your trading account. Not an issue, you can buy shares worth 50,000 and sell it within 3 days to pocket more profit. Planning for intraday, well you can trade worth $$  – many brokers offer such terms. What they don’t mention is “earning for them” not “earning for you.” Apart from these, you may also receive SMS alerts or email alerts as trading tips from your broker. Have you ever seen, your broker offering any investment idea that is for 2-3 years holding period? They can’t offer because their broking business will dry up if you buy today and hold them for 2-3 year. On the contrary, wealth can only be created over the long run. In the short run, frequent trading can only increase your chances of losing money and increase broker’s earning.


Temptation from so-called analysts –

During bull market (while the market goes up) any Tom can consider themselves as an equity analyst. With the advent of internet, you will find thousands of self-claimed analysts over social media (Facebook, Whatsapp etc)  Whenever the market goes up, you will find television, newspapers, websites flooded with stock tips. Almost every analyst will draw a rosy picture and encourage you to invest in stocks. Surprisingly, the same analysts elope during a bear market (when the market goes down). The worst part is that during bear market these analysts will even mention avoiding stock market, fearing that it may fall further. The reality is that during the bear market, quality stocks are available at a cheap rate, and thus it is one of the best times to invest. Moreover, if you select quality stocks then overall market movement rarely matters. High quality businesses are always poised to do well in any  market situation. Don’t get carried away by any analysts.


Temptation from stock tips provider –

Nowadays, it is common to get phone calls, SMS alerts from various stock tips provider. Eye catching advertisements are so popular.  Remain alert whenever you notice high return promises. Many trading tips provider claim 50%+ monthly return from their trading strategy. If that would be the case then today every billionaire would be creating their fortune from stock trading. Reality says something different.



Overconfidence-

Suppose, you started investing during a bull market and successfully earned 45% return at the end of first year. All your purchased stocks were performing well. In such a situation, you may start thinking that you have mastered the subject very well. As the market moves up, so moves your confidence level, you keep on increasing your investment amount. You are now too aggressive. Suddenly market crashes and there comes a prolonged bear market. It is the bear market that separates intelligent investors from others. Don’t get lured and invest aggressively if you find your portfolio giving above average return during a bull market. The stock market doesn’t move linearly. It’s quite easy to make money during the bull run but difficult during the bear period. To become a successful investor, you need to learn the art of making money across all market situations.

Psychology and Investing: Overconfidence

Overconfidence refers to our boundless ability as human beings to think that we are smarter or more capable than we really are.

Such optimism isn't always bad.  Certainly we would have a difficult time dealing with life's many setbacks if we were die-hard pessimists.

However, overconfidence hurts us as investors when we believe that we are better able to spot the next Microsoft than another investor is.  Odds are, we are not.

Studies show that overconfident investors trade more rapidly because they think they know more than the person on the other side of the trade.  Trading rapidly costs plenty and rarely rewards the effort.  Trading costs in the form of commissions, taxes, and losses on the bid-ask spread have been shown to be a serious damper on annualized returns.  These frictional costs will always drag returns down.

One of the things that drive rapid trading, in addition to overconfidence in our abilities, is the illusion of control.  Greater participation in our investments can make us feel more in control of our finances, but there is a degree to which too much involvement can be detrimental, as studies of rapid trading have demonstrated.

Know-it-alls have a lot to learn. You never know as much as you think you do.

One of the biggest dangers with investing is over-confidence or the addictive nature of doing well.

This is hard-wired into human beings.

It is all about maintaining a sense of perspective, and sometimes we need to remind ourselves that we should guard against over-confidence as much as risk aversion.

You never know as much as you think you do.

Always try and see things from a new or different perspective.  It can be quite developmental.

One of the biggest dangers with Investing is Overconfidence

Quote:   

Re: uyafr selection October 2010 batch
« Reply #45 on: October 27, 2010, 10:16:15 AM »
Reply with quoteQuote
Quote from: smartinvestor on October 27, 2010, 10:09:42 AM
Agree with Uyfar...
GenY...please tell the MANY company that also doing well too...
DIGI? KPJ? Genting?
Here is the place we share information and earn $$$ together

yep, do u know how much is DIGI, KPJ Gentings ? hehehe if suddenly those counter drop.. kena kaw kaw, if go up.. the most 5-10%

BUT LCTH, I dont see how it can drop much, but if go up... even if go up 100% it is still cheap and good. So think for yourself, is it worth risking on those counter already too high up or buy a counter which is still rock bottom and rock solid.

http://www.investlah.com/forum/index.php/topic,11510.msg195753.html#msg195753


The above was a post in October 2010 in a blog that I participate.

Here are the 5 Years charts of DIGI, KPJ, Gentings and LCTH performance.



Digi Share Price
Oct 2010  RM 2.50
July 2013  RM 4.70
Capital Gain 88%




KPJ  Share Price
Oct 2010  RM 3.80
July 2013  RM 6.50
Capital Gain 71%



Genting Share Price
Oct 2010  RM 10.50
July 2013 RM 10.50
Capital Gain 0%

versus



LCTH Share Price
Oct 2010  RM 0.28
July 2013  RM 0.18
Capital Loss  - 35.7%

From October 2010 to July 2013:
1.  The prices of the shares of Digi, KPJ have performed very well.
2.  Genting share price remained relatively unchanged over this period.
3.  The share price of LCTH has tanked significantly.


Questions I pose:
1.  Are higher priced stocks more risky than penny shares?
2.  Are higher priced stocks more risky because they have a longer way to drop?
3.  Are penny shares less risky because should their prices correct, the drop will be less?
4.  Why are higher priced stocks priced such, and why are penny stocks priced such?
5.  What are the fears that kept this "investor" away from Digi, KPJ and Genting?  Are these fears rational or irrational?
6.  What drives his enthusiasm to penny stocks?  Greed?  Ability?  Confidence?  Past gains?   Are these emotions rational or irrational?
7.  What single characteristic, if any, distinguishes the gains in Digi, KPJ and no loss in Genting, compared with LCTH?


What lessons can we derive from the above observations?
Please feel free to post your comments.

Just How Smart Is Wall Street?

 Posted: August 12, 2011 1:48PM by Stephen D. Simpson, CFA

Individual investors see a steady stream of paeans to Wall Street, praising not only the substantial resources of professional investors, but also suggesting (sometimes subtly, sometimes not) that these professionals are smarter and more capable than the average investor. While there are certainly plenty of columns out there decrying the mistakes of professional investors and pointing out that disciplined individuals can do just as well, the fact remains that the financial media overwhelmingly tilts towards the idea that Wall Street is smarter than you or me.

TUTORIAL: World's Greatest Investors

But is it really? The word "smart" has plenty of definitions, but Wall Street has such a peculiar inability to learn from certain mistakes that it seems worthwhile to question just how smart the Street really is.

They Can't Stay Away From the BubblesNothing of any real size can happen in the investment world without the involvement of institutional investors. So while retail investors are often dismissed as the "dumb" money, it is the professionals who ultimately add the most air to investment bubbles.

It was professionals, not individual investors, who awarded absurd IPO valuations to stocks like TheGlobe.Com, Geocities or eToys.com. Professional investors were also apparently happy to pay upwards of 30 times sales for Cisco (Nasdaq:CSCO), Qualcomm (Nasdaq:QCOM) and JDS Uniphase (Nasdaq:JDSU) back in the bubble days.

Only a few years later, institutions happily dove into the housing bubble. Institutions apparently were not bothered by data that clearly showed affordability was declining at a precipitous rate and that lending standards were abysmally low. In fact, institutions got so casual about the bubble that they happily relied upon models that told them housing prices could never fall - even though there were plenty of examples from outside the U.S. that showed what could happen.

These are only two examples of how the institutional community is all too happy to believe "it's different this time" and "prices couldn't possibly fall from here." The fact is, that the Street is happy to play a game of musical chairs because the players almost always believe they'll find a seat before the music stops … even if years of history suggests otherwise. (Home price appreciation is not assured. For more, see Why Housing Market Bubbles Pop.)

A Few Gaps in Their Due DiligenceAlthough plenty of institutional investors now claim to have spotted the shenanigans at Enron and Worldcom and shorted the stocks, those stocks would have deflated much sooner if all of these people were telling the truth. The fact is, plenty of institutions lost huge amounts of money in names like Enron, Worldcom, CUC/Cendant, Waste Management and so on, when their accounting scandals finally became unsupportable. In fact, when Enron blew up, well-regarded names like Alliance Capital Management, Janus, Putnam, Barclays and Fidelity owned about 20% of the stock in total, and most major firms held some number of shares.

Even in the wake of scandal after scandal, institutions have apparently not filled all the gaps in their due diligence. During the housing bubble and crash, institutions were largely blind to the balance sheet time bombs of financial companies like Washington Mutual and AIG (NYSE:AIG), to say nothing of their off-balance sheet liabilities. Even in the last few months, John Paulson reportedly lost millions of dollars on his position in Sino-Forest when evidence finally arose that the company may have grossly overstated its asset base. Likewise, plenty of other smart money investors have gotten caught up in other Chinese debacles. (For more, see Hedge Fund Due Diligence.)

Overconfidence, Especially in Their Own ModelsHowever smart Wall Street professionals are, it doesn't shield them from overconfidence in their abilities and their models. Time and time again some sharp-eyed professionals will spot a profitable anomaly in the markets - junk bonds or Latin American sovereign bonds that price in too much risk of default, undervalued mortgage bonds, unexploited absolute return strategies and so on. In the early days, there are in fact plenty of great opportunities, but eventually word gets out, other investors try to replicate the strategy and investment bankers rush to fill the supply of look-alike products.

The list of well-known implosions goes on and on - from the heyday of junk bond-fueled LBOs to the numerous emerging market sovereign debt debacles to the "see no evil" models of the U.S. housing market. In almost every case, though, the fundamentals change, the experts fail to notice, more leverage gets poured into the process and it all blows up in everyone's collective face.

The case of Long Term Capital Management (LTCM), though a 13-year-old story now, is still a great example. Mixing very experienced and successful Wall Street professionals with a small army of PhDs, LTCM used very high amounts of leverage to exploit small inefficiencies in the market. Unfortunately, early success brought more capital into the firm than it could manage, more leverage was employed to squeeze bigger returns out of smaller anomalies, and then suddenly some of the key relationships underpinning its models fell apart. The end result was a spectacular failure - one so large that the federal government stepped in to help the unwinding process from destabilizing the financial markets.

TUTORIAL: Credit Crisis: Historical Crises

The Bottom LineThese are just a few brief examples of the "factory seconds" that Wall Street churns out with surprising regularity. What of the fact that Wall Street routinely puts its faith in the projections and promises of management teams with no record of competence or success? Or what of the fact that Wall Street professionals routinely trust their investors capital with people and instruments that have previously failed?

The fact is, Wall Street is made up of people and people (even well-trained and well-compensated examples) make mistakes. Whether its greed, overconfidence or a sincere belief that it is somehow different this time, Wall Street cannot resist taking a chance on money-making opportunities. The point here is not to bury Wall Street or excoriate its professionals for their mistakes. Rather, the point is that everybody makes mistakes and investors should never be intimated out of their own good judgment and common sense just because the "smart money" thinks differently. (For more on smart money, see On-Balance Volume: The Way To Smart Money.) 

Read more: http://financialedge.investopedia.com/financial-edge/0811/Just-How-Smart-Is-Wall-Street.aspx#ixzz1VKT47J00

Sorry to burst your bubble, your investment is overpriced

Annette Sampson
October 9, 2010

They're frothy and insubstantial. Mere lightweights in the world of solid matter. But bubbles can prove mighty dangerous phenomena, especially in the world of investments.

Investment bubbles have been brought back into focus by the mere uttering of the word by the Reserve Bank head of financial stability, Luci Ellis, in relation to the residential property market at a conference in Brisbane this week.

Let's be quite clear. Despite continuing speculation that Australian house prices are in bubble territory this was not what Ellis was claiming. Rather, Ellis said the market was showing ''welcome signs'' of cooling. But low yields on residential property, she said, limited the potential for price appreciation.

Advertisement: Story continues below ''Buying an asset because you expect the price to rise in the future, well, that is actually the academic definition of a bubble,'' were the attention-grabbing words. ''So that would be undesirable and seen as a problem.''

Never mind that future capital gains have long been the prime motivation for Australian residential property investors. Ellis said recent rises in rental yields and a levelling off in prices were a good thing, but this has not dampened the speculation over whether Australia, like the US and so many other countries, is in danger of a housing bubble burst.

The International Monetary Fund also bought into the housing bubble debate this week cautioning that our house prices may be overvalued and a correction could hit household wealth and consumer confidence.

The arguments on the Australian housing market have been well-documented. Those holding the bubble view point to historically high levels of debt by households, high house prices in relation to incomes, and low rental yields as being unsustainable. The property bulls point to continuing undersupply of housing and strong immigration as putting a floor under house values.

Both have a point. But in the post global financial crisis environment where debt still has the potential to derail the economic recovery, it would certainly be prudent to err on the side of caution.

However the argument raises the broader issue of how investors can shield themselves from the inevitable crashes that follow investment bubbles, while enjoying some of the profits while markets are rising.

As the chief economist of AMP Capital Investors, Shane Oliver, points out, investment asset bubbles are an inevitable outcome of human nature. Investors have a natural inclination to jump onto popular fads by buying into investments that have been star performers - a trend that pushes prices up further and further until they become overpriced and unsustainable.

While you would think investors would be once bitten, twice shy, history also shows that bubbles emerge regularly, often arising from the ashes of the most recent crash. While it's easy to get caught up in bubbles, the fact that we've had so many of them also provides investors with the tools to identify when and where bubbles are emerging. There are always those who will claim each bubble is different, but the reality is that they all follow similar patterns. The signs are there for those prepared to look for them.

Dr Oliver identifies a combination of conditions that tend to lead to bubbles.

• Chief among these is a supply of easy money, though the bubble generally does not start to form until something happens that generates popular interest in the investment, it becomes overvalued, and speculators jump in fearing that if they don't buy now they'll miss out on the next chance to make some fast profits.
• Other commentators have pointed out that bubbles are also characterised by overconfidence. Even when it is obvious that prices are overvalued, pundits come up with arguments to justify why ''this is different'' or why the old rules don't apply to this investment. A classic example was the tech boom of the late 1990s when any company claiming a vague connection to information technology could command a heady price on the sharemarket regardless of its earnings. Indeed, even if it had no earnings.
• Another common feature of bubbles is that they are generally fostered by government policy that encourages speculation to grow.

Oliver says the liquidity that has been generated by governments in response to the global financial crisis and the bursting of the bubble in US house prices has created fertile conditions for the next bubble. Easy money is providing the fuel for investors to jump into something seen as safe, offering a good return, and removed from the assets that caused the last set of problems.

His pick of prime bubble candidates are shares in emerging markets, gold and commodity prices, and resource shares.

However for a bubble to exist, speculation and overvaluation must also be present - and while there is definitely speculation in these markets, and prices have risen strongly, Oliver argues they have not yet reached bubble levels.

His verdict is that we are in the ''foothills'' of the next bubble, which more than likely has several years to run.

It is also important to note that while the most memorable bubbles are those that come to a spectacular end, not all investment bubbles lead to a sudden collapse in prices. Bubbles can end with a bang, or they can simply run out of steam, providing investors with a long period of underperformance rather than overnight losses. Historically this has been the more common trend for less volatile (and less liquid) assets such as direct property investments.

In that respect, a cooling in Australian house prices should indeed be welcomed.


http://www.smh.com.au/business/sorry-to-burst-your-bubble-your-investment-is-overpriced-20101008-16bz5.html

Why investors behave the way they do

Why investors behave the way they do
Published: 2009/04/01

Learning from other market players’ mistakes; analysing how and what they think, can help an investor emerge as a winner in the market

In recent years, behavioural finance has been gaining grounds in trying to explain the financial anomalies in the stock market. These anomalies, which cannot be addressed by traditional financial theory such as the market efficiency theory may sound purely theoretical, but you cannot brush aside the need to understand the psychology of investors as it plays a big part in driving the stock market.

What is Behavioural Finance?


Behavioural finance is the study to explain the financial behaviour from the psychological aspect. Over the years, market psychologists have discovered that the two primary emotions that drive investors' risk-taking behaviour are hope and fear. There are a few key behavioural concepts that will help us to understand why some of us behave in certain ways when it comes to making investment decisions. In this article, we talk about four of such concepts:

* Regret theory


Regret, a simple enough concept to understand by any layman, refers to the emotional experience that one goes through when confronted with the wrong decision that he or she has made. It manifests itself in the form of pain when one feels responsible for not doing the right thing. When you look back at your investment history, try to recall the state you were in when you missed the chance to cut losses or missed the opportunity to buy a stock that you knew you should have bought because it was considered a good buy. Try and remember how you felt when the price of that particular stock that you did not buy increased subsequently. This emotion often becomes embedded in someone's mind in such a way that it regulates his or her future actions and decisions.

As a result, most investors make it a habit to avoid selling a loss-making stock and instead hope that the price will rebound eventually - all this, to avoid the feeling of regret. They would much rather make a paper loss than admit that they have made a mistake. In some cases, where the bad decisions happen to be recommended by their financial advisers, investors will put the blame on the advisers to avoid regret.

* Prospect theory

Prospect theory developed by Daniel Kahneman and Amos Tversky (1979), states that "we have an irrational tendency to be less willing to gamble with profits than with losses". Kahneman and Tversky found that when confronted with the choice between accepting a sure loss and taking a chance, most people will choose the latter. This phenomenon is called "loss aversion", which basically means that in general, people hate to lose. So, when faced with a situation involving loss, they become risk takers; they take the chance even if there is only the slightest hope of not having to lose.

On the other hand, when presented with a sure gain, they usually become risk-averse. Investors who behave this way tend to mark their stocks to the price that they originally paid to secure them and not to market. As such, they aim to get even before closing out a position. This type of investors usually ends up holding on to their loss-making stocks for far too long, which may very well prove detrimental to them in the end.


* Overconfidence

It is human nature for us to over-estimate our abilities and shower ourselves with a little too much confidence, i.e, overconfidence. Studies show that investors are often overconfident when it comes to their ability to predict the market's direction. Oddly enough, this is something that is more prominent among novice investors. Compared to experienced investors, those who are new to the market tend to set higher return expectations and end up being overwhelmed by the unfavourable outcome. As a result of overconfidence, some investors tend to trade too frequently only to get unsatisfactory returns or worse yet, losses. With the convenience of online trading, some even quit their full-time jobs to do day trading, thinking that they have the ability to predict the market and earn fast money. These are the people that usually end up getting burned if they do so without proper understanding of what they have been buying and selling, especially when the market is highly volatile.


* Anchoring


This is a behavioural phenomenon in which people tend to extrapolate the past into the future, putting heavier weight on the recent past. At times, when there are new announcements from companies, analysts fail to adjust their earnings forecast for the companies to reflect the latest information due to the anchoring effect. As a result, they land themselves with a few surprises when positive news become more positive and vice versa.

What has been discussed above are a few common behavioural phenomena experienced by investors that are useful to know. By understanding the psychology behind investors' behaviours, you can learn to recognise mistakes and avoid making such mistakes yourself. Learning from other market players' mistakes; analysing how and what they think, can help you emerge as a winner in the market.

Securities Industry Development Corp, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

http://www.btimes.com.my/Current_News/BTIMES/articles/SIDC9/Article/


» RELATED STORIES
What causes stock prices to move?
Shield yourself from scams
Raising children to be 'money-smart'
Key habits of successful investors
Understanding effects of economic indicators on stock market
Insight into bonds

Behavioural Finance

Behavioral Finance

By Albert Phung

Whether it's mental accounting, irrelevant anchoring or just following the herd, chances are we've all been guilty of at least some of the biases and irrational behavior highlighted in this tutorial. Now that you can identify some of the biases, it's time to apply that knowledge to your own investing and if need be take corrective action. Hopefully, your future financial decisions will be a bit more rational and lot more lucrative as well.

Here is a summary:

• Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining.
  
• Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler.
  
• The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand.
  
• Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and intent.
  
• Seeing is not necessarily believing as we also have confirmation and hindsight biases. Confirmation bias refers to how people tend to more attentive towards new information that confirms their own preconceived options about a subject. The hindsight bias represents how people believe that after the fact, the occurrence of an event was completely obvious.
  
• The gambler's fallacy refers to an incorrect interpretation of statistics where someone believes that the occurrence of a random independent event would somehow cause another random independent event less likely to happen.
  
• Herd behavior represents the preference for individuals to mimic the behaviors or actions of a larger sized group.
  
• Overconfidence represents the tendency for an investor to overestimate his or her ability in performing some action/task.
  
• Overreaction occurs when one reacts to a piece of news in a way that is greater than actual impact of the news.
  
• Prospect theory refers to an idea created by Drs. Kahneman and Tversky that essentially determined that people do not encode equal levels of joy and pain to the same effect. The average individuals tend to be more loss sensitive (in the sense that a he/she will feel more pain in receiving a loss compared to the amount of joy felt from receiving an equal amount of gain).
  

Table of Contents
1) Behavioral Finance: Introduction
2) Behavioral Finance: Background
3) Behavioral Finance: Anomalies
4) Behavioral Finance: Key Concepts - Anchoring
5) Behavioral Finance: Key Concepts - Mental Accounting
6) Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
7) Behavioral Finance: Key Concepts - Gambler's Fallacy
8) Behavioral Finance: Key Concepts - Herd Behavior
9) Behavioral Finance: Key Concepts - Overconfidence
10) Behavioral Finance: Key Concepts - Overreaction and Availability Bias
11) Behavioral Finance: Key Concepts - Prospect Theory
12) Behavioral Finance: Conclusion

Heuristic-driven biases: 2. Overconfidence

2. Overconfidence

People tend to be overconfident and hence overestimate the accuracy of their forecasts. Overconfidence stems partly from the illusion of knowledge.

The human mind is perhaps designed to extract as much information as possible from what is available, but may not be aware that the available information is not adequate to develop an accurate forecast in uncertain situations.

Overconfidence is particularly seductive when people have special information or experience - no matter how insignificant - that persuades them to think that they have an investment edge. In reality, however, most of the so called sophisticated and knowledgeable investors do not outperform the market consistently.

Another factor contributing to overconfidence is the illusion of control. People tend to believe that they have influence over future outcomes in an uncertain environment. such an illusion may be fostered by factors like active involvement and positive early outcomes. Active involvement in a task like online investing gives investors a sense of control. Positive early outcomes, although they may be purely fortuitous, create a illusion of control.

Is overconfidence not likely to get corrected in the wake of failures? It does not happen as much as it should. Why?

People perhaps remain overconfident, despite failures, because they remember their successes and forget their failures.

Harvard psychologist Langer describes this phenomenon as "head I win, tail it's chance". Referred to as self-attribution bias, it means that people tend to ascribe their success to their skill and their failure to bad luck. Another reason for persistent overconfidence and optimism is the human tendency to focus on future plans rather than on past experience.

Overconfidence manifests itself in excessive trading in financial markets. It also explains the dominance of active portfolio management, despite the disappointing performance of many actively managed funds.