Goodbye or Good Buy? Are you treating investments as a gamble?

I used to put my money in a bank's deposit account until I was 18. Then, why did I stop? I simply lost interest. Make cents? It’s time for a change!

Back then during National Service, there seemed to be a mental void and I needed to find something to fill my intellectual curiosity. I started reading e-books that delve upon investments, psychology and economics. Friends at that point in time started picking up on investments as well and that sparked my interest in the area of Finance. You can actually make money while playing a real-time PvP game! Or so I thought...

It all started out with signing up for a demo account with a Foreign Exchange broker with the very ambitious aim of making large returns. Trades with various tickers USD/JPY, EUR/USD, GBP/AUD started filling up my page. Things went well for the first few days with a stretch of green pastures on my orders. Filled with anticipation, I committed a few months’ worth of NS allowance into playing what I then thought to be an exciting game.

My eyes were fixated to the screen – especially on my favourite USD/JPY pair. The low spread, the brow-raising Abenomics, and my accurate predictions in the past slowly built my confidence and ego. I thought I was a prodigy in this money-making system. But to my horror, my trades soon flashed like a spoiled traffic light – a juxtaposition of red and green. Then, as if a green line parted the red sea and all my trades, except one, were making a loss. I was down by 42% and I refused to get out of my trades.

I was devastated from such a heart-wrenching experience. Many thoughts raced through my mind and uncertainty trampled my heart. I thought I could redeem myself by placing more in, and I did – a reckless entry of 2 months of my NS allowance. It’s no surprise – I made even more losses, totalling to about $1,300.

How demoralising did it feel when you were a kid having spilt your bowl of noodles on the floor, watching that helpless mess that you’ve made? I was lost, demoralised, and felt like giving up on this ambition of mine. I’m already 4 digits down, should I go further with no promise of making it back? Will it be another mistake? What will happen to my savings? In a short position, I lost money shortly. In a long position, I longed to break even.

Though, thankfully, I decided that what doesn’t kill you make you stronger – sounds ironic coming from a psychology enthusiast isn’t it? I assimilated my mistakes, sought advice from friends who were doing well, and I held my fort. For the next 6 months, I was back into the green from where I have left off from a measly bit – and that’s joy unspeakable. It wasn’t just about the profits but the light-hearted feeling that you have improved from 30 marks in an examination to a 90.

Looking back in retrospect, such foolishness could possibly stem from being ignorant about certain cognitive biases. Reading pop-psychology books in my later years such as “The Art of Thinking Clearly” by Rolf Dobelli and “Thinking Fast and Slow” by Daniel Kahneman has brought to my attention that it’s probably not our skills but how we make decisions that affects our results. In fact, up till today, they are books that will be in my wrapped gifts for friends.

The following cognitive biases below are only representative of my experiences and also, non-exhaustive:

1. Gambler’s Fallacy and Hot Hand Fallacy

It’s easy to note that my early trades were mostly made on impulse and a lack of understanding. My thought process was: a short period of price increase will mean a continuation of going upwards, but after a long period of price increase, it will mean a drop in prices. The reasoning and gut feeling behind this isn’t too far off the truth and there are Technical Theories behind such ideas such as “Three White Soldiers”, “Resistance” and “Double Top”. However, having insufficient knowledge at the back of my hand has blindly led me into placing my money in highly risky situations and losses. Picking up on my technical knowledge has allowed me to judge with greater statistical and psychological accuracy on trades and it has been particularly rewarding.

2. Overconfidence and Illusion of Skill

After winning big on the demo-account, I thought that was simply an innate ability to read and predict charts. Proven wrong in real trades where real money is placed on the line, this overconfidence soon turned into humility. Call me superstitious but there’s the element of Beginner’s Luck in all that we do and I’m a recipient of that in the demo-account. Overconfidence blinds our drive to learn more sophisticated ways to improve our investment styles and our mistakes. We must recognise that we are all amateurs until a proven track record – and in fact, even the best investors are always learning, checking and questioning their own trades.

3. Sunk Cost Fallacy and Escalation of Commitment

“A long-term investment is a short-term investment that failed.” Going into the red and having in mind that hundreds were lost before sets a new internal target to get back up to the principal amount. However, this mentality is a problematic one. Imagine having $1000 in and making a loss of $500. This puts you at a 50% loss. However, in order to hit $1000 again, you’ll need to make an extra 100% from $500. The movement of the market must fit your predictions twice as much now! Perhaps, you may want to earn back that loss of $500, and so you top up another $500 to patch up that loss, in hopes of making a 50% return from your new base of $1000.

This escalation of commitment could potentially result in even more losses and skew your perception of your actual skill level. Focus on the present situation to better play the game.

4. Availability Bias

Japanese news on Shinzo Abe’s economic reform were rife back in 2015 on whether the economy will recover. Analysts around the world produced reports on how interest gaps were widening between the US and Japan, on how the inflation target may not be reached and eminent signs of fiscal weakness from a somewhat April Fool’s joke on consumption tax hike. All these news point to one thing – the depreciation of the Yen. It’s a no-brainer to go long on the USD/JPY pair. I took great heed to the news and decided to long the USD/JPY pair at around the start of June. It was a wrong decision, but why? Highly salient pieces of information may cloud our minds into thinking that event will be sure to come to pass when a possible turn of events could happen. Also, the more salient the event, the more likely other investors would probably have priced in this expectation and nothing’s left for you.

5. House Money Effect Not everything is about losses and I’m definitely not a terrible enough investor to not make a single gain. I have made some returns as I raked up more experience. Making gains can be thrilling and you would hope to continue in your winning streak. However, I felt that I was treating the gains as a bonus rather than registering it into my pocket – losing this amount is trivial. I soon realised that I was making bigger and riskier trades as my risk-to-reward ratio went up. Although my gains exceeded losses, the whole portfolio became riskier and definitely not the most efficient that I could potentially achieve. Perhaps, once again, we can remind ourselves to focus on our current portfolio value and not from where we started.

Why would pumping balloons cost money in the future?

And yeah, you may have guessed it – Inflation.

Many nowadays may choose to adopt investing on their own to combat future price hikes.

“知彼知己, 百战百胜” or “知彼知己, 百战不殆” – a very well-known phrase from Sun Tzu that if you know the enemy and know yourself, you need not fear the result of a hundred battles. Knowing your own trading style is only a necessary but insufficient condition in achieving success in trading. Knowing your enemy – the mind that has been playing tricks on you – is the key to winning every battle. Ultimately, after having a better understanding of the market and tools available, and along with a sharper mind to spot cognitive biases, trading could be particularly rewarding.

If you're interested to chat on this topic or to exchange ideas, please feel free to drop me a message on Telegram @elijah2212, LinkedIn, or through email elijah.thj@gmail.com!

http://www.prudential.com.sg/fc-disclaimer