Saturday, December 10, 2005

Psychology of Investing

On the recommendation of my long time friend and trading collaborator, John Kercheval, Adjunct Professional Lecturer at Georgetown, I have been reading The Psychology of Investing by John R. Nofsinger. At barely 100 pages, paperback and costing $34, it better contain something tradable. It does.

Here's an example, appropriate for end of year tax selling. Chapter 3 is about, "Pride and Regret." It sets out the psychological basis by which most investors sell winners too soon and hang on to losers too long. Winners generate pride, losers generate regret. We are programmed to seek pride and avoid regret. But if you do the numbers, it is almost always financially correct to do the opposite, hang on to winners and sell losers. Winners tend to continue going up after the sale, losers tend to continue going down while still being held. Taxes take a chunk out of the winner's proceeds and losers offer no tax advantage by being held. Yet investors are typically overwhelmed by their embedded desire to seek pride (sell the winner) and avoid regret (hang on to the loser). Worth $34 to be aware of this sort of behavioral bias? You bettcha.

That was a summary of just one chapter of ten in this book. The nine others similarly contain tradable observations about the human condition and how it works against even the best and brightest traders/investors. Although not yet through the book, I wanted to bring it to everyone's attention and to thank John publically for bringing it to mine. A good tip doesn't always have to involve a stock.


No comments: