Dealing With The Shortcomings Of The Human Brain
February 21, 2011 2 Comments
Since we can’t overcome the tendency of the human brain to make mistakes while working through heuristics , here is a list of things we can do to reduce the effects of the shortcomings of the human brain.The more we can incorporate these points into our investing procedures and systems , the better the quality of our returns.The checklist is form Whitney Tilson’s ‘How to Avoid – and Profit From – Manias , Bubbles and Investor Irrationality’.
•Be humble–Avoid leverage, diversify, minimize trading
–Don’t try to get rich quick
–A watched stock never rises
–Tune out the noise
–Make sure time is on your side (stocks instead of options; no leverage)
•Get a partner
–someone you really trust –even if not at your firm
•Have written checklists; e.g., my four questions:
–Is this within my circle of competence?
–Is it a good business?
–Do I like management? (Operators, capital allocators, integrity)
–Is the stock incredibly cheap? Am I trembling with greed?
•Actively seek out contrary opinions
–Try to rebut rather than confirm hypotheses; seek out contrary viewpoints; assign someone to take opposing position or invite bearish analyst to give presentation (Pzena’s method)
–Use secret ballots
–Ask “What would cause me to change my mind?”
•Don’t anchor on historical information/perceptions/stock prices
–Keep an open mind
–Update your initial estimate of intrinsic value
–Erase historical prices from your mind; don’t fall into the “I missed it”trap
–Think in terms of enterprise value not stock price
–Set buy and sell targets
•Admit and learn from mistakes –but learn the right lessons and don’t obsess
–Put the initial investment thesis in writing so you can refer back to it
–Sell your mistakes and move on; you don’t have to make it back the same way you lost it
–But be careful of panicking and selling at the bottom
•Don’t get fooled by randomness
•Understand and profit from regression to the mean
–Pretend like you don’t own it (Steinhardt going to cash)
–Sell a little bit and sleep on it (Einhorn)