In my personal life I am an expert in lazy forecasting; for example, India will win 12 medals in the 2016 Olympics because in the London Olympics we doubled our Beijing 2008 tally of three medals to six. In my professional life, I see clients, competitors and myself getting routinely sucked into such forecasting. Whilst this makes life profitable for a broker like myself – I see some investors who are rabidly bearish on India without sound logic to justify such bearishness and simultaneously I see others pumping many millions of dollars into Indian stocks. It has led me to think about why we get trapped by poor logic and mental biases. Listed below are the four most common mental traps I encounter in my daily grind in the market.
Trap 1: What you see is all there is (WYSIATI)
Our intuitive mind is designed to think fast, suppress doubt and uncertainty, and make sense of partial information in a complex world. Furthermore, much of the time the coherent story it pulls together is close enough to reality to support reasonable action. In fact, our minds are built in such a way that neither the quality nor the quantity of evidence that we have impacts the action that we are taking (due to our beliefs). We often fail to allow for the possibility that evidence that should be critical to our judgement is missing – what you see is all there is (“WYSIATI” is Nobel laureate Daniel Kahneman’s acronym for this).
Trap 2: Anchoring and priming
Psychologists have highlighted how easy it is for even rational people to get “anchored” and “primed” by even random data. For instance if 1,000 people are asked to guess, “How old was Churchill when he died?” versus “Was Churchill more than 130 years old when he died?” the answer to the latter question will be significantly higher than the answer to the former one. Reason: The figure 130, nonsensical as it is, offers an anchor and thus primes respondents to give a higher answer.
Similarly, if I anchor you every day with negative newsflow on India (corruption scandals, power blackouts, accounting scandals, profit warnings, etc.), this is likely to anchor you and drag down your growth and valuation estimates for all things Indian. Before you know it, you will be mentally trapped into undervaluing good Indian companies.
Trap 3: Aversion to the unfamiliar
As Nassim (“Black Swans”) Nicholas Taleb has pointed out, our mind wants to make sense of the world around us by constantly seeking patterns and building stories of what we are seeing (even if there are no real underlying patterns or stories). And because it is easier for our mind to build patterns and stories of what is familiar, the mind prefers the familiar over the unfamiliar.
Not only is the squalid, decrepit milieu of most Indian cities unfamiliar to most FIIs (who tend to be more used to well-scrubbed money centres such as Jakarta, Manilla and Hong Kong), the chaos of Indian politics and the unfamiliarity of this downturn in India (even many domestic investors have never seen a downturn of this magnitude) makes it hard for investors to feel at ease about India. Thankfully, a few investors know that political chaos and squalid urban infrastructure have little to do with stockmarket performance. (China has neither, and yet the Chinese market has not gone anywhere during the past three years).
Trap 4: Overweighting low probabilities
Our minds tend to overweight the probability of events which have happened recently. So, for example, if you have been thinking about plane crashes recently (perhaps because of a recent plane crash captured graphically on TV), it will impact your beliefs about the safety of flying. Similarly, if you are exposed repeatedly to newsflow about corruption scandals in India, it will have a bearing on your thinking regarding the pervasiveness of corruption in the country. That, in turn, could alter your perception of the trajectory of the Indian stock market (even if there is no link between political corruption and the direction of the stock market).
So, how can we see the world without mental biases?
I am as susceptible to these biases as my clients but to avoid big behavioural errors here are a few remedies that my colleagues and I have implemented:
* Look outside the community of brokers, bankers and investors and seek alternative perspectives on the conomy, perspectives such as those of taxi drivers, doctors, check out clerks in supermarkets, regulators, etc. Such perspectives can provide a sanity check on what’s happening in the economy
* Spend at least as much time on digging up “primary data” from customers, competitors, suppliers, policymakers, etc, as you do on desk research
* Finally, travel and socialise widely and thus expose yourself to unfamiliar sights, sounds, tastes, smells and cultures. Allow yourself to be taken to new realms of emotion and thereby take your mind away from the biases that drag you down.