Warren Buffett's trading psychology (II)

On the one hand, intuitive judgment saves the mental resources of human beings. On the other hand, it also brings illusory thinking to human beings. As a result of the sensitivity, intuition has obvious limitations when making judgments, which leads to hindsight bias, over-sensitivity, beliefs, and over-confidence tendencies, which are fully reflected in the stock market.


1. Hindsight bias

Hindsight bias refers to the tendency to use the outcome of events after they have occurred to understand why and how they happened. People tend to ignore the natural advantages of hindsight understanding and further downplay the complexity and difficulty of ex-ante decision making. Hindsight bias is pervasive and part of human nature and this misconception tends to make people overestimate their own abilities and underestimate the abilities of others.


Warren Buffett tries to avoid such mistakes in his investments, and in fact, his investment in Berkshire Hathaway in the 1960s (which was mainly in the textile industry) taught him a very big lesson when he was forced to close down his textile business in the 1980s, which had been losing money. Itformed a very important investment rule for Buffett, which is to invest in companies that maintain consistent business principles and avoid companies that are in trouble. Don't overestimate yourself and expect to do better than the operators of that company and be able to turn a profit. "Charlie and I haven't learned how to solve a company's problems yet," Buffett admits, "but we have learned how to avoid them, and our success has been in concentrating on the one-foot fence we can cross, rather than discovering a way to cross the seven-foot fence. "


2. Over-sensitive effects

The oversensitivity effect is the psychological tendency to overestimate and exaggerate the influences of the event that has just occurred, while underestimating the effects of other factors that affect the overall system, thus making false judgments and overreacting to the behavior. Sensitivity enables people to detect anomalies in time and speed up their reactions to them, but it can also increase the magnitude of their reactions and make them overreact.


Take the United States "9-11" event as an example. "After 9/11, the scene of the terrorist hijacked planes crashing into the World Trade Center towers in New York, greatly stimulated the nerves of the American public. People greatly overestimated the danger of air travel and tended to choose other travel methods, and the U.S. aviation industry then entered the Great Depression. However, statistics show that air travel is the safest of all modes of travel, even after taking into account the airline disaster of 9/11, with an accident rate one-third of that of train travel. The over-sensitive effect is reflected most vividly in the stock market investment. In the rising stock market, people tend to be over-optimistic, and believe that the bull market is never-ending, so over-pushed up the stock price. In falling stock market, people tend to be over-pessimistic, tend to believe that the bear market is inevitable, so over-pressed the stock price. Buffett believes that it is people's irrational behavior that makes stock prices fluctuate excessively around their value, creating opportunities for investment. He believes that good investors should take advantage of this phenomenon. "Fear when others are greedy. (in 1969 when Buffett found that people in the stock market had gone crazy when he decisively sold all the stocks and dissolved the investment fund).  Greedy when others are afraid." (in 1973, 1974 after the U.S. stock market fell sharply into a bear market, Buffett and low batch position successful bottoming). Buffett believes that "stock market decline is not a bad thing under certain circumstances, investment opportunities are revealed precisely from the ebb and flow of investment."


3. the phenomenon of belief fixation

Belief fixation is the phenomenon that once people have established a belief in something, especially a theoretical support system for it. it is very difficult to break them of that belief, and they tend to ignore evidence and information to the contrary even when it is presented. From a psychological perspective, the more people try to justify their theories and explanations, the more closed they are to information that challenges their beliefs.


The phenomenon of belief fixation is a very important psychological phenomenon in stock investing. As stock investors tend to predict the ups and downs of the stock market and stock price fluctuations, and all kinds of securities analysts also make gains by predicting stock price fluctuations. However, people tend to fall into the trap of thinking in terms of belief fixation, ignoring the appearance of downward signals when the position is full, and ignoring the accumulation of upward factors when the position is empty. Buffett sees through this misunderstanding of thinking, advocating an understanding of the difference between investment and speculation, that should be a rational investment rather than irrational speculation. It should be said, this is the essence of Buffett's law of thought - value investment.


Keynes, Graham and Buffett have all explained the difference between investment and speculation. According to Keynes, "Investing is the activity of predicting future returns on assets, while speculation is the activity of predicting market psychology." For Graham, "An investment operation is one that is based on a thorough analysis to ensure that the principal is safe and will yield a satisfactory return. An operation that does not satisfy this requirement is speculation." Buffett believes, "If you're an investor, you're looking at what the asset - in our case, the company - is going to do in the future. If you're a speculator, you're primarily predicting price changes independent of the company." By the above criteria, the Chinese stock market is still a highly speculative market at the moment.


4. tendency to overconfidence

The tendency to overconfidence refers to the phenomenon of intellectual conceit in people's judgments about past knowledge, which affects the evaluation of current knowledge and the prediction of future behavior. Even though we know we have made mistakes in the past, our expectations of the future remain quite optimistic. The main reason of overconfidence is the tendency of people to recall bad judgments at moments when they were perfectly right. Thus, they believe that it was just a random event that happened and had nothing to do with their deficient abilities. The tendency to overconfidence affects almost everyone. Johnson's overconfidence caused the United States to fall into the quagmire of the Vietnam War in the 1960s. Nick Rison's overconfidence caused the collapse of the Centennial Bank of Bahrain. It can be said that the tendency to overconfidence is the greatest enemy of human rational decision-making, this tendency is also prone to make people produce the illusion of control, as a gambler, once you win is attributed to their own gambling skills and foresight, once you lose that "almost became, or accidental bad luck. From a rational point of view, gambling and buying a lottery ticket is a game that is probable to lose, yet there are countless gamblers and players who are addicted to it due to the illusion of control.


It's not easy to truly get rid of the tendency to overconfidence and outdo yourself. The vast majority of stock investors are convinced that they are able to judge the market's upward and downward trends and that by "buying low and selling high" they will make gains that far exceed the gains of the broader market index. The irony is that 90% of investors (including institutional investors) lag behind the growth of the broader market index. Despite this clear evidence, people still believe that they have the ability to be part of the 10%, and refuse to accept the foolishness of stock index fund portfolios as an insult to their intelligence. Buffett is well aware of his limitations and believes that the broader market is unpredictable and that what can be captured is an evaluation of the value of the company behind the stock and a projection of future earnings, so he never expects to benefit from predicting the broader market.