Self-education is one of the most important things a biotech investor needs to pursue all the time. You need to stay updated with news. In addition, you have to watch prices and figure out what they mean. And you have to learn how to interpret scientific reports on some levels. If you fail at any of these levels of self education, you put yourself at greater risk of being a victim in the stock market.
Today, I want to tell you about a book that has shifted the game for me, personally, as far as investing goes. If you have not heard of it, then this is an introduction you need. And if you haven’t yet absorbed the messages of this book, then I hope this overview will give you some insight into why you should bite the bullet and read it.
I am not necessarily a strong proponent of absorbing every last book on investing that you can get your hands on. If you’re not a strong reader, then this path can get confusing and unhelpful. But there are some essentials you should partake in.
“Thinking, Fast and Slow” by Daniel Kahneman is one of those books. At first glance, it looks like nothing more than a pop-sci non-fiction book. But as you probe deeper, you’ll find important lessons for your investing and for life in general.
You can follow this link to purchase on Amazon. (Note: contains an affiliate link)
“Thinking, Fast and Slow” follows the work of Nobel Prize-winning psychologist Daniel Kahneman. His most famous work relates to cognitive psychology, particularly in describing the programs that we follow when making decisions.
The book summarizes, in his own words, a large body of the work that led to his Nobel Prize. His work forms one of the pillars of behavioral investing that you can see taught in a number of investing circles.
Kahneman describes the way we think as incorporating two “systems,” System 1 and System 2. One is a specialist at taking information quickly and making a decision. You might experience this as your “gut reaction” to a situation, particularly one where you don’t have time to ponder the proper solution to the problem. The second system is designed to take in the evidence, consider the outcomes, and arrive at a logical conclusion.
You can imagine which of these systems ends up driving the common investor! Kahneman goes on to describe how the interplay of these systems and the general tendency toward laziness we have in our thinking leads to critical failures in logic. The fact that the logical, methodical portion of our brains requires particular effort is a key focus of the entire book.
Kahneman then moves to describe 48 different “heuristics” that we use to make decisions. A few of the most important of these for you include:
- Priming – We can be subconsciously influenced by ideas and visuals we’ve been exposed to recently. For example, if I talk with you about food, then you might fill in the blank of this word, SO_P, with a “u,” making the word “soup.” However, if we discuss cleanliness, then you will be more likely to fill the word in with an “a.” The net effect of this is that we must be aware that there are many different factors that can contribute to our thinking, even if we aren’t aware of them.
- Cognitive ease – When trying to solve a problem or answer a question, we tend to reach for the easiest answer that we can recall. If it’s easy to remember, then it feels more “correct.” The effect here is that you can be swayed by simple exposure to the same messaging over and over again.
- Associative coherence – The more a story makes “sense” to us, the more likely we are to believe it, even though in real life (and the investing world), many things occur that do not develop into a coherent story.
- Confirmation bias – Our tendency to seek information that confirms a conclusion we held from the outset.
- Substitution – When facing a difficulty question or problem, we have a tendency to substitute the answer altogether with an easier question. For example, if someone asked you “Do you like [political candidate’s] stance on [complicated economic issue]?” you would be likely to avoid answering the challenging question, and generally focus on whether you like the candidate or not.
- The law of small numbers – We are generally ill-prepared to deal with matters of statistics, and we find it difficult to understand that small sample sizes are prone to extreme outcomes. This can make a huge difference when it comes to intrepreting reports of scientific literature.
- Confidence over doubt – We tend to trust people who are more self-assured, rather than those who express doubt in a complex situation. This leads us to becoming “believers” in a specific idea, which can end up biting us in the end.
- The anchoring effect – We tend to screw up our estimates simply by having a point of reference. If a stock price is $5 today, then all of your estimates will subconsciously be weighted to that value: $5. For the investor, this can have all kinds of implications for how they consider individual stocks over a long period of time.
- Overlooking luck – As gamblers, we can fall into the trap of thinking that past experience will dictate our chances for future outcomes. If you have a string of losses, you may feel “entitled” or “sure” about your luck shifting for the better. Furthermore, when we do have good or bad luck, we seek to explain the cause of our good fortune, often settling on an illogical conclusion.
- The planning fallacy – We often jump into a risky venture or investment without seriously considering the worst-case scenario. This can make us lose sight of the details that can mean the difference between success and failure.
- Loss aversion – We tend to fear losses more than we like winning, which can lead us to put too much weight in the risk of failure when the chances for success are really quite good.
As you can plainly see, this is just a taste of the information in the book. If you’re not already familiar with these concepts in behavioral psychology, this may be the best and only introduction to the subject you’ll ever need.
Benefits for the investor
As I state in The No BS Plan, fear is one of the primary challenges you need to overcome as an investor. If you can’t, you’ll never ascend to the level of consistently making good decisions, and you’ll be more likely to lose money.
But how do you overcome fear? First, you must understand it, at least on some level. Now, it is important to understand that simply recognizing where we fail isn’t enough to overcome the mental programs that we’re subject to. Consider this optical illusion:
You can take a ruler and measure the two lines that make up the main part of this image. However, that will never be able to overcome the fact that, to your brain, the top figure looks more narrow. You will never be able to “see” them as equal.
Similarly, you are still going to be human after reading “Thinking, Fast and Slow,” and you will still have the same risk of falling victim to cognitive biases. But if you can understand them, you can come to address them. You develop a radar for when you’re prone to make bad, emotional calls.
This is a critical skill to develop for every investor, whether you’re a diehard long or a day trader. You will still feel the need to buy in on hype, only to have the stock be pumped and dumped. If you develop the ability to recognize these heuristics, you are well on your way to overcoming them. If you want to stop getting screwed in cancer investing, then overcoming biases and misinformation will put you two steps ahead of everyone else.
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