Your Guide for Intelligent Wealth Management

Empower yourself with proven strategies for intelligent wealth accumulation.

A warm hello to all new readers! I’m glad you are on board.

New here? I’m Michael and on a mission to make beating the stock market as easy for you as choosing your favorite ice cream. I write an algorithm that does exactly that.
How it all started. The journey so far.

Have you ever found yourself making a decision you knew was wrong, only to realize the consequences later? We’ve all been there, caught in the web of our own biases.

We humans are a flawed species. Most of the time, we’re predictable and irrational. We skip logic and listen to our gut. There are many areas where our gut feeling is a good thing, but in investing it couldn’t be further from the truth. Here, gut feelings usually make us poor instead of rich.

The Party Trick Phenomenon

The more we steer clear of these biases, whether by choice or through a system that works for us, the better the outcome will be. A vivid illustration of this is the scenario where a surge of investment floods in at the peak of a fund's performance. It’s like a party trick where the guy who tells the best jokes gets the most attention and the crowd around him gets bigger and bigger. At some point, he is running out of jokes and the crowd vanishes in search of another distraction.

Heuristics

We humans developed mental shortcuts – called heuristics – to identify snakes when we still lived in caves. When it was a matter of life and death, we had to react quickly and get away from the creature that could kill us. Heuristics helped and still help us avoid these situations, but it’s still only useful for “survival”.

Investing is more like chess – a strategic long-term game, where sticking to a plan, or after deep investigations, switching to another plan makes you survive in the long run. There are a bunch of biases that keep us from getting rich - and here are just three - but with an enormous impact on your wealth.

The Anchoring and Adjustment Bias

Let’s start with the most common one – anchoring and adjustment bias. It’s when we rely too heavily, aka anchor, on one piece of information when we buy a stock. Thinking it’s a great investment, but then its price drops like crazy, we’re shocked at first, but we stick to it like honey to our t-shirt.

We “just want to break even” and sell as soon as we reach the entry price to get out of this awkward investment. In these situations, we usually focus on the buying price to decide the “right” price to sell again, instead of thinking about the selling price before we buy.

A good way to overcome this bias is to ask yourself: Is the business or company still in good shape? Because, as Buffet and Munger famously said. Price and value are two different things. And yet, our starting point influences us too much and we don’t adjust to new information.

So ask yourself what has changed in the business, rather than gluing yourself to the anchor price.

The Overconfidence Bias

I’ve started with this bias for a reason. Because it’s closely connected to the next bias – overconfidence – it fools us in a funny way. Being too confident makes us quickly think we’re always right. When we buy a stock and make a nice profit, it’s because we “know” the market and we “know” what we are doing, not just “dull” luck.

The Base Case Bias - Steve's Dilemma

Kahneman and Tversky, these two legends in behavioral finance, discovered that when we take a test and are asked later how we did, we usually think we did better than we actually did. The more difficult the test and the less we know about the topic, the more we “hallucinate” about our actual performance – especially when we get lucky.

A lot of us, myself included, fell into this trap after the 2008 crash and hopefully, we’ve since learned our lesson and paid down our ignorance-debt. If you still blame “the market”, or “bad luck” because your performance is behind market average, well I guess there are still some lessons to be learned. Maybe the next bias will help to understand where this sticky and expensive ignorance debt comes from.

Let’s start with a short classic test in behavioral finance developed by the two above gentlemen.

Read the following text and guess the result.

Steve is a very shy and withdrawn, invariably helpful, with little interest in people, or in the world of reality. A meek and tidy soul, he has need for order and structure and a passion for detail. How do assess the probability that Steve is engaged in a particular occupation from a list of possibilities? For example farmer, salesman, airline pilot, librarian, or physician?

Think about it for a second and then read on.

…

Most people say that Steve is a librarian. But these people fall into the next bias – the so-called, neglect of the base case bias. They completely ignore the base case instead of focusing on it. In Steve’s case, it suggests that there are more farmers than librarians in our society. This would make it more likely that Steve is a farmer rather than a librarian, just based on the numbers - the base case.

Strategies to Success

Systematic behavior and sticking to your investment rules & checklist create opportunities. But only if you also handle your personal biases or you’ve already overcome them.

For me, it was code that helped me to overcome my biases. Code is rational, it’s rational by default. That’s one reason I coded my stock-picking algorithm. It eliminates human biases and by that, I have an edge in the long run. Why?

Most investors ignore value stocks because they are unsexy and instead they buy into the growth stocks story - because it feels good. We’d rather brag about owning the hot stock than the boring basic material stock. Although we know that stocks with a high PE ratio have less room to improve than a stock with a low PE ratio. Yes, this is a very simplified way of looking at the stock market, but you get where I’m coming from.

Why is that?

We are social creatures that prefer to feel good. And most of us know how well actively managed “expert” funds perform in the long run. The majority underperforms the market. Because these experts suffer from the same biases, they are as unreliable as the rest of us.

Remember.

"Even if we are aware of our biases, we must recognize that knowledge does not equal behavior." - James Montier

With this knowledge, you can gain an edge, and edges have a compounding effect. Compounding is the strategy of gaining huge rewards from small, seemingly insignificant actions.

The Game of Probabilities

Small choices + edge + consistency + time = significant results and returns.

Investing is a game of probabilities, where small advantages compound over time to yield significant results. Like a skilled poker player, we must stick to our rules and avoid emotional pitfalls and biases to come out ahead in the long run.

I prefer to have an edge by eliminating behavioral biases by using a quantitative value model because I think these models are the ceiling rather than the floor. I think that our personal judgment rather cut the ceiling down than expand it.

Nassim Taleb wrote a brilliant book called Fooled by Randomness where he says:

“… the only success I’ve had is going around my emotions rather than rationalizing them. …”

In the end, it’s not just about what we know—it’s about how we behave.

Which brings me to what I did this week.

Behind the Scenes

The Progress

I’m about to finish the liquidity code and set a threshold that doesn’t affect the results negatively. It takes longer than expected because liquidity levels change over time and I still have to understand where and how to set the “right” one.

But I’m getting there :-)

The Plan

Share the results with you ASAP.

What’s on my head

Understand it :-)

Nuggets I’ve enjoyed

This week was packed with research, so nothing here this week.

Hit that heart if you love wealth!

Michael

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Recommend The Economy Rocket to your readers and friends

I share my stock investment story without sugarcoating – you get the good, the bad, and those tricky ego trips. I'm developing a service with a mix of smart code and proven investment strategies, making stock analysis a thing of the past if you wish. Why? Because life offers so much more beyond the confines of stock analysis.

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Disclaimer:

The information in this article is my personal opinion. I’m not a certified investment professional. It is not consulting, nor does it constitute investment recommendations.

I do my research carefully and follow my personal investment strategy.

The stock market is a complex building with its own rules. There are no rules set in stone, like the rules of physics.

Therefore, use the contents of this newsletter at your own risk and do your own research as well. Investing in the stock market can lead to a total loss of the capital invested.