Everyone makes mistakes when investing. We learn from our mistakes from the moment we are born. By recognizing when we make investment mistakes and making the necessary adjustments to our investing discipline, investors must learn from them. Do we recognize our investing error and learn from it when we lose money on an investment, or do we blame the market or bad luck instead? We must recognize our investing mistakes and then learn from them if we want to beat the market and make money from our investments. Unfortunately, it is much more difficult than it appears to learn from these investing mistakes.
You may have heard of this experiment at some point. It is an illustration of Antoine Bechara’s failure to learn from investing mistakes during a straightforward game. $20 was given to each player. Each round of the game necessitated a decision from them: either invest $1 or not. The project moved on to the next stage if the decision was not to invest. Players would give the experimenter one dollar if they decided to invest. After that, the experimenter would flip a coin in front of the players. The player lost the dollar if the result was heads. The player’s account was credited with $2.50 if the outcome came out tails up. After that, the task would move on to the next round. 20 rounds were played all together.
There was no evidence of learning during the game in this study. The percentage of players who chose to continue the game decreased to just over half as it went on. Players would have realized that it was best to invest in every round if they had learned over time. However, as the game progressed, a decreasing number of players decided to invest. In fact, they were getting worse with each round. They assumed they had made an investment error when they lost and decided not to play again.
So, how do we correct our investing errors? What strategies can we employ to overcome our “bad” behavior and improve our investment skills? We simply don’t recognize our own mistakes or those of others as such, which is the main reason we don’t learn from them. We have a variety of mental mechanisms in place to shield us from the terrible reality that we frequently commit errors. When we experience a loss, like in the previous experiment, we also become reluctant to invest. Let’s take a look at some of the investing mistakes we need to avoid.
Hindsight is a wonderful tool, I knew. We can always say that as Monday morning quarterbacks, we would have made the right choice. It’s easy to say, “I knew that, so I would have invested on each flip of the dice,” when looking back at the previous experiment. Why, then, didn’t everyone do that? They, in my opinion, let their feelings take precedence over rational decision-making. It’s possible that after losing a number of trades in the past, they concluded that they had made an investment error and now fear losing another trade.
The advantage of looking back is that we can use logic to figure out what we should have done. We are able to steer clear of the feelings that get in the way. Emotion is the worst enemy of any good investor and one of the most common mistakes in investing. I suggest that every investor write down the reason they are choosing to invest in order to assist in overcoming this feeling. To remove the emotion that leads to investment mistakes, it is important to document the logic behind an investment decision. The goal, in my opinion, is to get to the point where you can say, “I know that,” as opposed to “I knew that.” You are utilizing the logic that you typically employ in hindsight to your advantage by removing emotion from your decision.
Self-Congratulation Every time we make a successful investment, we congratulate ourselves on our decision-making abilities. However, when an investment fails, we frequently attribute it to bad luck. Psychologists say that this is a natural mechanism that we humans have. It is a bad trait for investors to have because it causes them to make more mistakes when investing.
I have discovered that I must document each of my trades, particularly the reason I am making the decision, in order to combat this unfortunate human trait. The outcome allows me to evaluate my choices. Did I make the right decision? I can at least claim skill if that’s the case; luck could still be to blame. Was my assertion correct for a bogus reason? If that’s the case, I’ll keep the outcome because it makes me money, but I shouldn’t fool myself into thinking I was really doing it right. I must determine what I missed.
Was my reasoning incorrect? I made a bad investment decision; do I need to learn from it, or was I right all along? After all, bad things do happen. I can only hope to learn from my investment mistakes by analyzing my decisions and the reasons behind them. This is a crucial step toward developing real investment expertise.
Luck Changes into Knowledge The market is made up of a series of actions that have a cause and effect but are not always obvious. Some very successful individuals have displayed some interesting behaviors as a result of this cause and effect. Some baseball pitchers, for instance, are known to avoid crossing the white chalk line while playing. You’ve probably heard of a lot of “superstitions” that people believe are true to help them succeed.
In a 1987 experiment conducted by Koichi Ono, participants were asked to respond to a signal light with points. They weren’t told to do anything specific, but they were able to pull three levers. They were aware that points were awarded regardless of what they did, but they could only see their score on a counter. In terms of points awarded, they were ineffective in any way. They noticed strange behavior from the participants as they tried to get as many points as they could during the experiment. The majority of subjects engaged in superstitious behavior, primarily through patterns of lever pulling, though there were a few who engaged in elaborate or even strenuous behaviors. The beginning of each of these superstitions was a coincidence. The participants might pull levers in a particular order in some instances. Even more bizarre behavior was observed in other instances, such as a person jumping off a table and then jumping up to “score” points by touching the ceiling. Keep in mind that the points were given out on either a fixed or variable schedule, not based on what the participant did.
The point here is that, as humans, we frequently believe that insight is luck. We are unable to effectively analyze the situation and determine the true cause of our success or failure. This conduct will cause financial ruin when investing. We must first document our investment decisions and then evaluate the outcomes to help us overcome our natural tendency. If we want to become successful investors, this assessment process is essential for each of us because it enables us to learn from both our successes and our failures.
Learn from Investment Mistakes What should you record before making a trade to help you avoid investing mistakes? Regarding a stock I’m considering, I like to look at three categories. In the beginning, I take a look at a number of fundamental facts like earnings yield, return on capital, revenue growth, insider holdings, the industry, and free cash flow. The fundamental information helps me determine whether this is a successful business with potential, good management, and growing earnings. I determine the company’s inherent dangers after reviewing relevant financial information, including SEC documents. Competition, market share, insider dealings, any pending litigation, and other potential threats include In this situation, one must attempt to identify and critically evaluate each potential risk. Last but not least, I examine the stock’s chart in an effort to locate zones of support and resistance. I get the trailing stop loss, potential entry points, and exit targets from this. I conclude these sections with a written trading strategy outlining my anticipated trading strategies. Before making a trade, all of these investment factors should be documented. I review them after the trade is finished to see what I can learn to avoid investing mistakes in the future.
Before making a decision, we must document our actions in order to learn from our investing mistakes. When evaluating our results, we must also be honest with ourselves. As we’ve seen, it’s very easy for each of us to put on a happy face and pretend to be better investors than we actually are. Without distorting the feedback we get from our decisions, we need to evaluate our investing skills critically. Those of us who are able to acquire this useful skill will greatly benefit. Those of us who are unable to put this knowledge to use will, at best, be doomed to mediocrity and will probably lose a significant amount of their capital before even considering investing.