A set of rules to develop a behavioral edge – Part 5

Investment psychology

Hobgoblin of little minds

I dare say we all think we are open minded. There are a lot of things I believe about investing. I convince myself that if you point out the error of my ways I will certainly see the light. But, the reality is that we are all too consistent and unchangeable in our views. Think of politics or religion or investing.

“A foolish consistency is the hobgoblin of little minds” are the often-quoted words from Self-Reliance, the essay by the American philosopher and essayist, Ralph Waldo Emerson. The essay is Emerson’s plea for people to open their minds to new ideas, avoid preconceptions and false consistency.

Confirmation bias

Behavioral psychologists call this a confirmation bias. Our mind searches for confirming evidence that we are right and shies away from contrary evidence. This bias pops up all over the place. It is insidious.

There are two good messages here. First, there is something we can do about it. Second, Mr. Market suffers from it in spades.

What our little minds do

This list should give you the general idea:

  • We read articles that support our view and don’t read articles that offer a contrary view;
  • We see only positive news about stocks we hold and ignore negative news;
  • We tend to remember things that agree with our views and forget things that don’t;
  • When we have bought energy stocks, we will see articles everywhere supporting the idea;
  • We ignore or downplay contrary evidence;
  • We seize on evidence that confirms our point of view;
  • We surround ourselves with people who share our view;
  • We stick with our approach to buying stocks even if it no longer works:
  • We stick with a sector or theme or story beyond its best before date;
  • We find it hard to turn on a dime when our thesis has gone cold;
  • It’s easy to find people to say ‘yes, you’re right’. It’s hard to find people to say, ‘no, you are wrong’;
  • We discuss things with friends who may be too polite to disagree with us;
  • When we talk to people who disagree, we tend not to listen to understand, but to listen to prepare to reply;
  • We don’t encourage others to offer contrary views;
  • We don’t seek out contrary evidence or views;
  • We fail to consider alternative, more likely explanations;
  • We are preprogrammed to believe the status quo won’t change;
  • We are preprogramed to believe that things that haven’t happened before won’t happen;
  • Any of us could come up with other examples!

Gap-to-edge rules

Let me give you my gap-to-edge rules to counter foolish consistency. They are my version of what Daniel Kahneman (Nobel Prize in economics) calls risk policies. Kahneman describes risk policies as decision rules that are always applied in similar situations. Avoid your behavioral gap and gain an edge over Mr. Market’s foibles.

This post is part of a multi part series titled ‘A set of rules to develop a behavioral edge’.

So far there have been four posts and four sets of gap-to-edge rules:

Part 1 the problem of short term thinking.

Part 2 the attractive trap of extrapolating the most recent past into the future

Part 3 control our animal spirits when faced with risky situations.

Part 4 the herd mostly gets it wrong

Gap-to-edge rules for this post

Gap-to-edge rule: Consciously and on a regular basis look for and read evidence and opinions that disagree with your current views.

Gap-to-edge rule: Make a point of talking to people who disagree with you and listen to what they have to say.

Gap-to-edge rule: Cultivate an open mind and independent thinking.

Gap-to-edge rule: Remain skeptical and flexible regarding your own approach to investing.

Gap-to-edge rule: Be on the lookout for Mr. Market’s refusal to give weight to evidence in plain sight that is contrary to his views.

Gap-to-edge rule: Be alert to company management falling into the confirmation bias trap.

Gap-to-edge rule: A foolish consistency is the hobgoblin of little minds.


Readers wishing to read deeper into this subject can check out the Motherlode Chapter 14. Changing our minds

And particularly Sections:

14.01 Admitting you are wrong

14.02 Preconceived ideas about your approach to investing

14.03 Path dependence

14.04 Flip-flopping

14.05 We jump to conclusions and then look to support them

14.06 Data mining

14.07 Delusions

14.08 Mr. Market’s preconceived beliefs

14.09 Conclusion


Other posts on investment psychology

This post is part of a series. Readers are invited to read Investment psychology explainer for Mr. Market – introduction this will give you a better understanding of some of the terms and ideas and give you links to other posts in the series.


You can reach me by email at rodney@investingmotherlode.com

I’m also on Twitter @rodneylksmith


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