Be RATIONAL.

If you hear the above conversation, what would you say about the girl?
I would say- "She is not Rational." But there is nothing to laugh at. The financial equivalent of her is there in most (if not all) of us.

Charlie Munger was asked a few years ago to explain how he achieved his amazing success in the stock market. He thought for a second, and then replied simply: “I’m rational.”

Lets see five major irrational behaviour (complete list will take a book rather than a blog) that we tend to make in relational to stock markets-

(1) LOSS AVERSION BIAS- If we are given 50-50 chance of winning one dollar v/s losing one dollar, we tend not to play the game. Even if chances are made 75-25 in our favour, we tend to avoid the same. Even if magnitude is made in our favour (like two dollars for winning against one dollar for losing), we tend to not play. Reason- Pain of Losing is more (almost double) than Pleasure of Winning.
However, if we are asked to take a loss of 2 dollars v/s 25% chance of losing 10 dollars, we tend to take the risk. Same reason- 2 dollars loss hurts, while in second case, there is some Hope that we won't lose anything.

Equity Markets are volatile. We can suffer occasional losses. Because of loss aversion bias, we tend to avoid equity markets. Nominal but constant rate of 9% in FDs look much better than volatile rate of 15% in equities.

To avoid this- Look in Real Terms. FDs barely beat inflation while equities tend to (over the long run). What should you choose- Sure zero real return of FDs or possible high return from equities?

(2) AUTHORITY BIAS- Ok, fine. You decided to get into equities. But which one out of the thousands available?
You should buy the stocks recommended by the experts. After all, they are the experts. Right? WRONG.

Noble Winner Kahneman says- "

·         The acquisition of skills requires a Regular Environment, an Adequate Opportunity to Practise & Rapid & Unequivocal Feedback about the correctness of thoughts & actions."

In stock markets, the environment is far from Regular & Feedback takes a long long time. Hence, even after decades of experience, No genuine player (unless he is selling something) will claim himself to be an expert.

To avoid this- Don't take any advise (that you get from a so called expert) at face value.

(3) ZOOMING IN BIAS- So, you are not gonna take any expert advise either. Now what?
Look at the girl in the above picture again. She is concentrating on the pizza slice & not the whole pizza. She has Zoomed In too much & hence is facing the problem.

For being Rational, you should look at the Pizza (the whole business) rather then the individual piece of it (stock).
I have heard some people say this stock is too costly.. its selling at 1500 Rs. Some people (technical analysts) look at the price of each piece only. All these guys need to zoom out to see the complete picture.

To avoid this- Look at the business and its fundamentals rather than stock price movements.

(4) ANCHORING BIAS- So, you will analyse the whole business. When will you buy a stock? At 52 week low? At 3 year low? At lowest P/E? At lowest P/B? NO.
All these are Price Anchors which we tend to latch on to while buying a stock.
If you are buying/ holding/ selling a stock based on your buying price, you are falling for Anchoring Bias.

To be rational, you should buy when stock is selling at a sufficient discount to its value. Price is what you pay, Value is what you get.

(5) INSTANT GRATIFICATION- So what next after buying a stock below its intrinsic value.
Don't Sell it too soon. We tend to go for instant gratification with our stocks.

Let the price converge to value & till then Have patience. Patience is a Virtue.

If you hold on to your rationality when rationality is in such a scarcity, then you tend to have a big advantage in this game.
TRY TO BE RATIONAL (as far as possible)