Take me to PDF file - Online Share Trading

46
their homework and wait for clear-cut
technical and fundamental signals
that the trend has actually reversed
before entering any trade.
ANCHORING
A very interesting concept in
behavioural finance states that we
tend to hold on to certain events or
figures and use them as anchors or
reference points on which we base
our investing decisions. This is quite
common and almost everybody will
identify with this example. Suppose
you have bought a stock at `100 and it
rises to `140, yet you wait for it to rise
further. But the stock price starts
falling instead and reaches `70. You
then decide to get out of it if it reaches
`100 again. But when it does really
reach `100, you do not sell it. Instead,
you say that you will wait for it to
reach `140 again. This is because the
recent high of `140 has been
anchored in your mind.
Anchoring is a means for investors to
justify their decisions. Because the
price of `140 is anchored in the
investor’s mind, he feels that it is the
correct valuation for the stock and the
market forces are undervaluing it.
According to him, the stock will
reach the right price of `140, sooner
or later. What investors do not realize
is that the fundamentals of the
company or some such factors could
have deteriorated and that is what is
being shown in the price of the stock.
Repeated exposure to certain numbers
or events can also cause anchoring.
So, if you have heard one or more
technical analysts on TV say that if
the Nifty breaks 5,000 on the
downside it can go as low as 4,700,
your mind gets fixated on the number.
Once the Nifty breaks the
5,000-mark, even though the stock
you want to buy is available at a very
cheap rate, you still do not buy it
because you feel that the markets are
Beyond Market 10th Oct ’11
going to fall to as low as 4,700 and
you may get the stock even cheaper.
Eventually you miss your bus.
Remedy
a. Forget the highs and lows.
b. Do your homework properly. Plan
your entry and exits in advance and
stick to it.
c. Keep a sharp eye on any news
regarding internal changes or those
revolving around the company or the
industry on the whole.
ENDOWMENT EFFECT
Suppose your friend has gifted you a
digital camera worth `5,000 for your
birthday. But since you already have a
digital camera of your own, you
decide to sell it off. At what price
would you sell it for? Obviously, for
nothing less than `5,000 even though
you have not spent a single rupee to
purchase the camera.
Now consider a second scenario. You
are in need of a digital camera and
instead of gifting you the camera, you
friend offers to sell it to you. You
know that the price of the camera in
the market is `5,000. What is the
price that you are willing to offer to
your friend to buy the camera? Most
of us would be willing to offer just
`4000 or even less. Why then are we
not ready to sell for less than `5,000
and want to buy it at a lesser price?
This is called the Endowment Effect,
which states that humans believe that
something that belongs to them is
much more valuable than something
that belongs to others. Humans
experience a lot of pain when parting
with objects they own. Hence, we
note that we press the ‘buy’ button
very easily but pressing the ‘sell’
button is very difficult.
Thus, if you have bought a stock at
`100, you would ideally not part with
it if you are not getting `120 or more.
Endowment is the reason why people
hold on to their losing stocks. They
feel that just because they own it and
have bought it at a certain price, the
sell price that they are demanding is
justified and anything less than that
would be doing injustice to the stock.
This right price may never come and
they are stuck with the stock for life.
Remedy
Plain and simple. Do not get married
to your stock. Be prompt to lock-in
profits and do not hesitate to book
losses when needed.
CONFIRMATION BIAS
People tend to think only in a manner
that suits their preconceived notions
or thoughts. Hence, when processing
information they focus only on
information that confirms with their
line of thinking. Any contradiction or
opposing thoughts are comfortably
ignored. This is known as
Confirmation Bias.
For example, if you have a
preconceived notion that only low
P/E and high beta stocks are
multibaggers in the long run, you will
search only for those stocks that fulfil
these two criteria.
Furthermore, once you have
identified such stocks, you will
reaffirm your argument by focussing
only on the positive news surrounding
these stocks such as high net profit,
increased sales, etc. Any negative
news about the stock is completely
ignored. This sort of view can prove
to be very disastrous as it provides
only a one-sided view and obliterates
the complete picture.
Remedy
Carefully process all the news about a
stock - positive as well as negative.
Assess all the pros and cons, weigh
the risk to reward ratio and only then
take an informed decisioN.
It’s simplified...