The Hidden Traps in Your Investment Decisions
Biases and how it affects your
For those managing family wealth and long-term legacies, the goal is often more than just short-term gains; it's about building enduring prosperity for generations. Yet, a very human tendency, known as biases, can quietly undermine even the most thoughtful investment plans.
We read about Trump’s recent tariff announcements and have built our views that corporate earnings would be impacted due to the tariffs. Recent market news also supports our view. Please click here.
So, we made up our view that most stocks will decline, and we determine that the chances of a Fed rate cut is higher. Our view is supported by the Bank of England cutting rates.
But we didn’t look at the inflation, GDP and labour market numbers yet. We didn’t check the money flows, and how the macro environment works in this situation.
But we have already made a view, that a vast majority of coporate earnings will be affected by the tariff play, and that the possibility of a rate cut as a panacea.
What we see here are:
Confirmation Bias: we formed a opinion based on limited information we are aware of, and we decided on the future of the market.
Fact: Many companies have local supply chains that are not affected by the tariffs.
Loss Aversion: our emotional impact of losses is more that that of equivalent (or higher) gains. We expect that the market will correct, and sell the best performers (book profits) since we expect that the prices can correct in the near future. When? We don’t know yet.
Fact: There is no shortage of fundamentally sound, undervalued stocks in the market. Except, they might not be the ones you already know about. Since they are not over priced, the chances of a loss, in case of a market correction is very low.
Overconfidence: My macro strategy has always worked. The quant system I use is able to navigate the market really well. My fundamental analysis is super cool. I use ‘DCF on steroids’. While you are right, all of your analysis can explain the past, but can’t foresee the future.
Fact: The markets don’t need to agree to your analysis. Finding Alpha in the market often involves synthesis of the analysed information. As an example, I expect an earnings surprise, and I know that the stock price usually pulls back on the day the earnings is released. If I know that the stock is already undervalued, and I expect a strong pull back, I will aim for a ‘long’ position on the stock, once the price correction takes place. If I just looked at a quant strategy, I would have taken a ‘short’ expecting just the pull back. But because I synthesize multiple facts, and observe the market, I am waiting to go long.
Herd mentality: When the ‘Liberation Day’ announcements came out in April, what we found was quite interesting. We saw institutional flows that were ‘net sellers’ and a large number of ‘small buyers’ - retail investors who were ‘buying the dip’, on ‘extremely overpriced stocks’.
Fact: Focus on objective data. There is more noise than signal in the market. Magnificient Seven tech stocks such as NVDA, TSLA, META and the others have had several price declines since that event. If you intended to time the market (which isn’t recommended), buying when the big boys are selling isn’t a really good idea.
Recency Bias: A stock experiences an earnings surprise (double digit) recently. So I am going all in. What we didn’t look at, is two things - among the 500 stocks on the S&P 500, more than 200 of them have earnings surprises and over a 100 of them have double digit surprises. Either the analysts who predict earnings are shockingly incompetent or they are just shooting in the air. Secondly, this stock has had earnings suprises in the past, but is not fundamentally sound. If I go back 5 years, I find that the stock price has been flat for a very long time, because the earnings have been flat for a long time. What we see here is that, we took a recent piece of information, and we decided our investment thesis based on that.
Fact: An earnings surprise can be a signal, but only if the company is fundmentally sound.
So, how do we tackle this? Have a look at how we use a Graph Neural Network based system to constantly study the market and separate the signals from the noise. Visit https://helix.earth for more information.