Conviction to win helps one become better investor
The recent week has seen the domestic markets suddenly rallying and there are innumerable reasons given from...
The recent week has seen the domestic markets suddenly rallying and there are innumerable reasons given from FIIs (Foreign Institutional Investors) pumping in fresh money (they are back net buyers after November) to possibility of favourable result for the incumbent government to crash in crude prices to RBI cutting down interest rates, etc.
Suddenly, there's a clamor from many investors to go overweight on equities and a huge buzz to invest now. Inflows across seem to pick up along with the investor confidence and interest. How would a portfolio manager view these inflows and short yet sudden investor euphoria? The answer could be found from an interesting research on how punters behave at a poker game. Bet conservatively when winning and bet aggressively when losing.
Yes, you read it right! Though, it is inconsistent from the rational point of view, the behaviour is true with many of the statistics. In a study where they reviewed more than five hundred thousand online poker hands analysing how big gains or losses influenced short-term behaviour, the research concluded that 'after a loss about two-thirds of players are looser and more likely to bet to stay in a game than after a win'.
This research comes from Allison Schrager's soon to be released book, An Economist Walks into a Brothel. This is exactly contrary to people who as we judge on the sidelines would be doing. Should not we be betting more when winning and be cautious while losing? Evidently, it is not the case while someone sitting at the black jack table, winning there is also pretty stressful.
Unfortunately losing money has an opposite effect. While on a winning streak, they tend to count their chips, submit to the temptation and walk away. The conviction to hold on to the winners or winnings is difficult as players become paranoid and are paralysed by the fear of losing all those winnings back.
So, as and when we lose, instead of pulling out of the game, we try to win back and many times immediately. In order to do that we not only take more risks, but also larger risks and are exposed to higher possible losses. This is something as investors and advisors I have experienced by myself.
There are further records of this behaviour in the recent studies by Essentia Analytics in a paper called Holding the Line. This research involved in tracking the behaviour of investors over a period of ten years on how their winning and losing affected their short-term performance. A few snippets here of the study puts: only half of the portfolio managers changed their behaviour in one way or other when on a streak.
Nearly one in four changed in when winning and 41 per cent changed it when losing. When managers were on a winning streak, the majority of them traded less often and made fewer decisions. That is just as well because the decisions they make when on a winning streak tended to destroy value. When they were on a losing streak, managers typically traded more often and also in larger size, thus increasing the portfolio turnover. Those decisions tended to destroy even more value.
This only proves that majority of investors are overprotective of our winnings. We become cautious and change our behaviour which could possibly kill the very instinct which helped us to hunt (bet on a particular stock). As we become more cautious, we become less immune to the vagaries of the market as they revert to mean, always, over a period of time.
It is difficult to tread a stock market which starts with a gap up and your investment or stock is already up on price, these instances test your convictions and it is very difficult to contain the contrary instincts and continue to hold on to your original choices.
Stanely Druckenmiller was one of those legendary investors who could bet big and walk away at even a small loss once said, "the most important job for a money manager is to understand when they are hot or cold". We know how we would behave when hot or cold, but the most critical part is knowing at what stage we are at, acknowledging and acting there upon. This difference separates the greatest investors from the rest.
(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at firstname.lastname@example.org)