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Jag heter Alexander Wetterling och arbetar sedan 2013 som Portfolio Strategist på A. Stotz Investment Research i Bangkok, Thailand.
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27 mars

The S&P 500 Will Gain 20% This Year | Recency Bias

How to recognize recency bias

“The S&P 500 will gain 20% in the first year of the new Millennium!” said the yuppie analyst to an impressed journalist while sipping champagne and chewing on a lobster tail. Except, the yuppie analyst was dead wrong in this prediction; the S&P 500 fell 10% in the year 2000.

How could this, obviously well-paid, lobster-eating yuppie analyst be so wrong? Overconfidence is a likely candidate, but so is recency bias.

What is recency bias?

Recency bias is a cognitive error that tricks you into believing that what has happened recently will continue to happen again. Our yuppie analyst above thought the S&P 500 would gain 20% in the year 2000 because it had gained about 20% in 1999 and almost 30% in 1998.

By the same logic, as the S&P 500 returned about 20% in 2017 and roughly 10% in 2016, you’d be inclined to assume that the index will continue to gain in 2018. By something around 15% maybe (the average of the 2016 and 2017 returns) or even as much as 30% (in a continuation of the pattern 10%, 20%, etc.).

Your brain is wired in such a way that recent memories are easily accessible. Hence, it’s completely normal that you think the market will perform well when we’re in a bull market. Even though you, like most investors, are aware of the cyclical nature of the stock market.

Why is recency bias a problem?

Clouded judgment due to recency bias may make you hold onto stocks even though you acknowledge their high valuations or other warning signals. Conversely, it can also make you stay on the sidelines too, not buying stocks when they’re cheap and the market is depressed. Hence, you get the timing pretty much wrong both ways.

Furthermore, recency bias may lead you to invest in a fund that has had the best performance in the recent past or to allocate more capital to an asset class that performed strongly in the last few years. However, there’s a lot of research showing that this has been a losing strategy for many investors and that it is probably better to invest in recent losers rather than recent winners, De Bondt and Thaler (1985).

How to deal with recency bias

As with many cognitive biases, increased awareness takes you far when dealing with them. It’s unlikely though—and may even be suboptimal—that this will entirely change how your brain works, so you’re better off just making sure that the most recent events or performance are not the only data points you use to form a baseline for your decisions.

Another way to reduce the impact of recency bias is to use a “periodic table of investment returns” named and modeled after the periodic table of chemical elements. The Callan Periodic Table of Investment Returns seems to have been the first (feel free to correct me if I’m wrong in a comment below) where you can see annual returns of various asset classes over the past 20 years. Another take is Ben Carlson’s Asset Allocation Quilt. Have a look for yourself, and you’ll see that it’s not very often that the best performing asset class in one year is also the best performing in the next.

10 augusti 2017

You Say Valeant Pharmaceuticals Share Is Still Worth US$200?

How to recognize anchoring

What would be the reason for someone to think that a Valeant Pharmaceuticals share is still worth US$200? There may be many reasons for sure, but one of them is bound to be that the investor first bought the share at US$200 and, therefore, has anchored themselves to that price as the share’s value.

What is anchoring?

Anchoring is when we fixate on past information and then base our future investment decisions on this. One way is to anchor to the price you originally bought a stock for, but another is to anchor to the price target you expect it to achieve and then stick to your anchor even when new information suggests you should do otherwise.

Why is anchoring a problem?

Let’s say you bought Valeant Pharmaceuticals share at US$200 in April 2015, but then the price-hike scandal hit. Despite this turn of events, you bought it at $200 so your anchor remained that the stock cannot be worth less than this. But by the end of 2015, the share price was about half your buying price, and you would have lost 50% on your investment (plus even more if you had still kept it till today).

The world around us changes, and so do the fundamentals of the companies you invest in; as there are a variety of influences that can affect share price. Sticking to your anchor doesn’t make rational sense, as most of the time your anchor might not even have been set by rational principles. Yet, even if it was rationally set, as things change so should your estimated value.

How to deal with anchoring

Research has not really reached a consensus about who is more or less prone to be affected by anchoring. Some studies have found that experts or people with better cognitive abilities are less affected by anchoring. Others have shown that even court judges are affected by anchoring when they sentence people. One thing most studies have in common though, is that everyone seems to be affected by anchoring at least to some extent.

As with many of our cognitive flaws, awareness is the best medicine. Just by being aware of your anchor and acknowledging that it can become irrelevant due to new information, should you be able to deal with this bias. And when it comes to stocks, if you should anchor to something, anchor to value, not price.

4 augusti 2017

Warren Buffett Knows How to Deal with Painful Losses

How to recognize loss aversion

Remember that stock which you bought that went down by 30%, and you didn’t sell? If you are absolutely convinced that a stock will do well, but then the price falls by 30%, it’s easy to think: “It’s on sale! I’ll invest more” to avoid or delay the loss.

Let’s do a test from my previous post How Rational Are YOU?

Choose between A or B and if I contact you tomorrow to ask you to honor your bets, you’ll have to do it. ;)

So, Option A has an expected value of $50 and B has an expected value of $0. If you are like most people (sorry we’re usually not as unique as we like to think, so I assume you are), you chose option B. Which completely contradicts the rationality set out in expected utility theory (EUT).

What is loss aversion?

One of the reasons you may avoid selling a stock that is down 30% and that you would always chose Option B over A is that losses are painful, they’re more painful than an equal gain makes you feel good. Studies on loss aversion, starting with Kahneman and Tversky’s seminal paper in 1979, have found that you feel a loss 2-2.5 times stronger than an equal gain. This makes you try to avoid more losses, i.e. you are loss averse.

Why is loss aversion a problem?

You take on more risk to avoid sure losses. You keep that stock when it’s down 30% just because you don’t want to realize your loss. If you also follow your instinct that the stock is now on sale after a 30% drop, you may be taking on even more risk. Studies on loss aversion have shown that we’re risk averse when it comes to gains, but risk-seeking when it comes to losses.

For someone new to the stock market that has heard about stocks and stock market crashes, they might also make the choice to park all their money in saving accounts, not investing at all just to avoid all potential loss. Hence, completely trying to avoid any risk at all just because of the fear of losing.

How to deal with loss aversion

If you have always kept all your money in a savings account until now, you might want to consider investing at least some of it. If you choose to invest in the stock market, unfortunately, you’ll need to bear some risk to get the potential of gaining a return.

If you’re already in stocks, just admit to yourself that you can’t always win. Zero-based thinking can help you, e.g. What if you didn’t own that stock before it fell by 30%, would you buy it now?

Warren Buffett has worked out how to avoid the pain of losses: “Rule #1: Never lose money; Rule #2: Never forget Rule #1.” ;)

Stop-loss is a powerful risk management tool. It won’t ensure you never lose money, but the benefit of implementing a stop-loss is that you predetermine your future action and are not making decisions in an emotional state. Like when that 30% loss feels more like a 60-75% loss. Stop-loss helps to preserve capital and protects you from your own emotions.

26 juli 2017

The Illusion of Overconfidence

How to recognize overconfidence

Have you ever met that guy who always has the answer for everything and is certain about being right? Or worked with that colleague who thinks he’s (sorry, but these ‘guys’ are usually ‘he’) invaluable for the company, but actually anyone at the firm could do his job better?

Did you know that 93% of Americans are above-average drivers? At least, that is according to themselves. ;)

These are all examples of overconfidence.

What is overconfidence?

It may sometimes seem hard to draw the line between mere confidence and overconfidence, but basically, overconfidence means that you are more confident in your abilities and judgments than is objectively true.

What is objectively true isn’t always easy to determine, but let’s have a look at some research examples where there is no doubt about it being a case of overconfidence. We’ll look into three different distinctions of overconfidence: overprecision, overplacement, and overestimation.


Soll and Klayman (2004) found that answers within a 90% confidence interval—a range of estimated values—only contain the right answer about 50% of the times. You can test this theory with your friends easily.

Ask them to give you an interval estimate that they’re 90% certain includes the correct answer. Ask something like “How long is the Mekong river?” or “When did Genghis Khan die?” It should be a question for something they’ve heard of and have an idea about, but are unlikely to know the exact answer about.

What you’re likely to find doing this survey, is that many of your friends will give quite narrow intervals, often not including the correct answer, even though they might not really have an idea about the correct answer.


Zenger (1992) found that 37% of engineers rank themselves in the top 5% of performers in their field. But how can 37% of engineers all be in the top 5% for best performance? Correct, this is impossible. This is also math an engineer should certainly be able to do. ;)

Svensson carried out a study in 1981 concluding that 93% of American and 69% of Swedish drivers rate themselves as above average drivers. Again, this is too impossible to be true.

We generally like to look at ourselves in a positive light—which is not wrong in anyway—just be aware that you risk overplacing yourself in relation to others, when in fact you’re just succumbing to a positive illusion.


According to Clayson (2005), most students overestimate their performance on exams. Though much scarier, Christensen-Szalansky and Bushyhead (1981) found that many physicians overestimate the accuracy of their diagnoses.

In the world of investments, Odean released a paper in 1998 and then followed up in a 2000 paper together with Barber, where they showed that overconfident traders hold undiversified portfolios and trade more; which leads to worse performance.

Overestimation is also behind the illusion of control; when you think you have the power to affect the outcome of something, but in reality you actually have little or no real impact at all.

Why is overconfidence a problem?

Overconfidence can impact your assessment of the quality of the information you have and your ability to act on it. As you can see from the studies referenced above, overprecision can be an issue as people are more confident about the accuracy of their answers than is actually the case. While overplacement makes you think that you’re better than others, when in fact you may not be. As investing in the stock market is a zero-sum game—there is always a winner and a loser in a trade—overplacement may make you believe you’re smarter than other market participants. If that’s the case, you’ll end up losing money. And if your doctor is not as good as he or she thinks they are, you might end up dead.

As Barber and Odean pointed out, to overestimate your own abilities can lead to excessive trading and holding only a few stocks in your portfolio. Most of the time, such behavior simply leads to you losing your money in the market.

How to deal with overconfidence

Admit that you are overconfident, be humble, do your research, and accept that you don’t know it all. Awareness and admittance of overconfidence are the most important steps to beating it, because only then can you begin overcoming it. Question yourself and others to make sure that a decision is not made in overconfidence. Construct an investment framework based on research and sound principles. Always strive to learn more and develop your strategy, don’t get too comfortable even when things are working out well for you. It’s hard (maybe even impossible) to remain on top if you stop adapting and evolving, but it’s easy to keep that perception—making you overconfident.

20 juli 2017

Enron Was a Truly Great Company, I’ll Block You on Facebook if You Disagree

How to recognize confirmation bias

Remember the analyst that never even considered news that wasn’t positive about his favorite stock? Think about the analyst who had a “strong buy” on Enron when the share price was at $90 in mid-2000 and continued to say “buy” as the stock crashed to less than a buck by the end of November 2001. That analyst wasn’t really open to opposing news or arguments.

Or what about that friend on Facebook that blocks all friends that post or share content with opposing political views? Heck, maybe you’ve even done that before? 

What is confirmation bias?

Confirmation bias is the tendency to only search for and put weight on information that confirms your beliefs. The guy who still had a “buy” recommendation on Enron when other analysts and reporters started to question the company’s accounting standards refused to listen to anyone other than Enron’s own executives.

Or let’s focus on your friend who’s convinced that Hillary Clinton should have been the President of the United States and blocks his friends who are Trump supporters. Your friend is making an active choice to avoid opposing views, and in the end, is only going to see supportive posts in the Facebook feed.

Why is confirmation bias a problem?

You may ignore information that contradicts your belief. And this is an issue because you will stay convinced of an idea that might turn out to be wrong. Once again using the case of Enron, before all the dirty stuff was known, you might have done research and everything looked good. But when new opposing information came out, and it turned out that Enron was fraudulent, the right move was to change opinion. If not, you’d have lost the majority of your investment.

In our current time, it’s was reported in February that short sellers have lost $2 billion betting against Tesla’s stock this year. Traders remain certain that Tesla, which is currently only beginning production of their first mass market sedan, the Model 3, shouldn’t be worth more than Ford. While short selling is always a gamble, these traders need to remain cognizant that Tesla founder Elon Musk has a long history of disproving low expectations.

How to deal with confirmation bias

Always be open to opposing views, strive for objectivity and put your ideas to the test. With many things in life, and certainly in investing, objectivity and rationality are key. Being open to opposing views is not about always being proved wrong, but keeping an open mind and taking opposing views into account may also strengthen your view. The key is to strive for objectivity and truth, not what’s most convenient.

15 juli 2017

You Probably Didn’t Know It All Along

How to recognize hindsight bias

Have you ever met someone who stated, “I knew it all along”? Maybe someone who claimed to have known the crash was coming when the financial crisis in 2008 hit its worst. (I’m not saying no one knew it was going to happen, but your friends Average Joe and Typical Jill were most likely not among them. Why else would they have sat on huge mortgages and lost a large chunk of their retirement money in the stock market crash? I rest my case.)

What is hindsight bias?

Hindsight bias aka “I knew it all along” syndrome is the tendency to wrongly remember that you foresaw a past event was coming before it occurred. As the saying goes, “Hindsight is 20/20.” It’s easy to be knowledgeable about something after the fact. (Economists are often good at explaining events after they’ve occurred, making them seem predictable. ;) )

Why is hindsight bias a problem?

Well, it leads you to believe the world is more predictable than it really is, which can result in overconfidence. By believing that the stock market is more calculable than it is you might take very concentrated and leveraged bets, essentially, taking on a lot more risk than you can actually bear when the shit hits the fan.

How to deal with hindsight bias

Be skeptical of anyone who claims, after an event, that they had predicted said event. If Average Joe tells you that he foresaw the global financial crisis in 2008, ask him, “So, did you short subprime mortgages and Lehman Brothers then?”

When backtesting, consider what data was known and when, because as the word implies, you are using historic data. To avoid hindsight bias you need to consider when information was actually shared in real time to the public.

A good example is annual results. Assuming a company’s fiscal year is the same as the calendar year—i.e. books close on December 31st each year—it’s easy to believe this information is released at the same time. But in fact, it takes a few months to go public so everyone can access the data (depending on the country’s regulations)—it certainly wouldn’t be on December 31st.

24 november 2016

Become a Better Investor’s Top 5 Bloggare 2016

Vi har precis offentliggjort vår lista över de fem bästa investerarbloggarna 2016. Ranken baseras på våra Top 5 of the Week, vilket gör att endast bloggar på engelska kunde kvalificera. Men för det behövs kanske ingen lista med tanke på att de flesta finns samlade här på TradeVenue.

Vi började publicera Top 5 of the Week i januari i år med vår första någonsin den 18 januari. Till och med 18 november, har vi publicerat 44st Top 5 of the Week innehållandes 130+ bloggare. Vi har sammanfattat 220 investeringsartiklar i exakt 694 punkter!

Ta en titt på listan här: Become a Better Investor’s Top 5 Bloggers 2016

Gratulera din favoritvinnare eller allihopa!

Vi lanserar samtidigt två e-böcker:

  • Become a Better Investor’s 220 Best Investment Articles 2016
  • How to Not Be Your Own Worst Enemy


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