Thinking Errors and Investment Mistakes

Mark your calendar. The Silly Season for investing has begun.

Between now and the end of the year we’ll be facing three major demons: First, the Traditional October Willies. We will hear a lot of stories about the resemblance between October 1929         (or October 1987) and October 1999. I’ve heard these stories so many times I’ve begun to think of October 1929 as the investor version of the Monkey’s Paw story.

Second, we’ll have to survive the Year End Tax Selling Season. Between now and the end of the year any stock that has been a disappointment is likely to be sold so a capital loss can be realized. In a market with zero-tolerance for disappointment, this can mean still deeper declines for any stock subject to uncertainty or doubt. That’s a lot of stocks.

And, finally, we’ve got the End All event, The Great Millennium Clearance Sale. This year, and this year only, we’ll have to deal with the folks who’ll want to sell some shares “just in case” the Y2K Bug is a real problem.

Mix all three together with the fact that we’ve had a non-stop bull market since 1995, and things may get pretty dicey, making the next four months a good time to have your head on straight.

Which is why I have a book for you to read.

No, it is not one of the half dozen books on electronic day trading that have barged their way onto my desk. Nor is it a tome on the fine points of derivatives, understanding technology stocks, learning the rules of the New Economy, or mastering emerging markets. Indeed, this book isn’t about investing at all. And a medical doctor wrote it in 1980.

It’s “Feeling Good, The New Mood Therapy” by David D. Burns, M.D. (no relation). Written to examine the sources of depression, it is a self-help book that doesn’t require years of therapy, family exhumation, and the like. Now I’d like to suggest that investors should read this book and use it to examine their habits of investment thinking.

Why?

Because Dr. Burns believes that we create or worsen many of our personal problems through a small number of cognitive disorders— habits of thinking that distort both our perception and our response to events. Understand your habits of thinking, he says, and you can improve your life.

The same cognitive disorders also affect our investment decisions. Dr. Burns identifies ten of these disorders. I believe seven of them can be found in investment decisions.

  • All-Or-Nothing Thinking. This happens when you start seeing things in “black and white categories.” The best example of this is the investors who are at both extremes of the market— those who own gold in preparation for the Investment Apocalypse and those who own Internet stocks purchased on margin, in the belief that they are only a year away from massive wealth.
  • Overgeneralization. Investors who see a single down day or week as the beginning of the end when it is really just another week in the market.
  • Mental Filter. Somehow you can only focus on a single positive or negative detail and all other evidence is ignored. Many chat room investors suffer from this disorder, using one single chard of information as justification for an entire investment position.
  • Disqualifying The Positive. (Or negative.) You discard positive or negative news because it “isn’t important”, given your pre-existing opinion.
  • Jumping to Conclusions. Dr. Burns divides this into two parts. One is “Mind Reading” in which a person assumes they know what another is thinking. In the investment world, this would mean thinking that you know what the market is going to do next. No one knows what the market is going to do. “Fortune Teller Error” is another form of the same disorder. In this version you treat your own prediction as though it was a historical fact.
  • Magnification or Minimization. Sometimes called “the binocular trick”, the investor losses his sense of proportion, putting excess weight on the positive (or negative).
  • Emotional Reasoning. An investor who is feeling badly assumes that the world feels the same way and everything is bad.

You can learn the basics of this book in the first 43 pages of the $6.99 Avon paperback. It’s more than worth the investment of time.


This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.


Photo: Pixabay

(c) A. M. Universal, 1999