January 17, 2020 | Gaurab Subedi
Decision making is one of the important parts of investing. In the modern world, we make decisions after spending rigorous time on analytical and scientific thinking. We can easily justify our decisions if they are based on logical and rational thinking. For instance, if we reach into the conclusion that we should invest in the banking sector rather than insurance based on stock performance over the last five years and other analytical factors, then our decisions will be considered logically correct.
“ Psychology describes intuition as one of two general modes of thinking, another mode being analytic reasoning. Intuitive thinking is automatic, fast, and subconscious.”
Here, basically what we want to talk about is how two different styles of thinking can help us making investment decisions. Compared to analytical thinking, intuitive thinking needs less time and can be used to make quick decisions. Intuitive thinking is irrational as it doesn’t use facts and data. It is based on our quick sense or our feeling in deciding what action we should take.
However, it doesn’t mean intuitive thinking is useless while investing. Our experience and knowledge help us to generate good intuition and a good understanding of how people think and work in a particular situation, which can make us a smart investor in day trading. Especially in the stock market, intuitive thinking can make good profits and make us a successful investor. But crucial decisions must be backed by analytical and scientific thinking before we integrate our intuitive thinking.
Let us see the take of William O’ Neil who started a very successful financial paper known as Investors Business Daily.
A common market/investing advice everyone has heard is: “Buy low and sell high.” The advice is pretty straight-forward. However, another way of thinking about this advice is counter-intuitive. William O’Neil says that a more effective way to make money in stocks is to “buy high, and sell higher.”
On doing so, he also asserts that the fundamentals of a company’s stock are essential. They include assessing financial strength of the company, increase/decrease in its sales and earnings, management soundness etc. Similarly, the technical aspect and its analysis is equally important. They include analyzing price swings, volume, moving average, relative strength index and more.
The psychological state of the investors such as greed, fear, hope and despair can be studied through technical analysis. These emotions help explain dramatic increases or drops in a stock price even when the company seems to have strong or poor fundamentals.
Here is how he generated the idea.
Investors who buy stock at high price hold on to their stocks even when the price drops significantly. This behavior can be explained by the emotion of “not to be wrong” being very strong. When stock price of company with good fundamentals decreases, it is the right time to buy the stocks after analyzing specific technical patterns and market trend.
Many fundamentally strong stocks that have a severe downfall eventually move back up in price, but slowly. The stock will frequently move higher. A high percentage of people sell these stocks when they regain the original price they had paid to buy them. They will be happy to get what they have initially put to buy the stock because they have a fear that the stock will decrease again. When this stock reaches a new high, most investors (who were happy to get their money out) no longer own the stock.
This intuitive feeling of fear ignores the important analysis of the stocks that lead to a loss. The happiness of getting back their money after a loss diminishes their logical reasoning.
“If a person has held a belief for a long time, a single argument probably won’t change his or her belief immediately, which is especially true for any belief that an individual feel strongly about.”
O’Neil has become a successful and well-known investor using this philosophy. His reasoning is now logical for us because we think he must be right if he is successful. But the same logic may be wrong over time. If a person has held a belief for a long time, a single argument probably won’t change his or her belief immediately, which is especially true for any belief that an individual feel strongly about.
What we should learn from the successful investor is to follow analytical and logical reasoning while investing in stocks. We have many exemplary investors over time, and they might not accept each other, as it is with two Nobel Prize winners in the field of Economics, Robert J Shiller and Eugene Fama. Two of these economists shared Nobel Prize in 2013, but they don’t accept each other’s investing theories and explanations. Indeed, two of them follow an entirely different school of thoughts.
So, the take away of this article is that we should invest logically and analytically in the market based on the behavior of market and what best serves our investment goals. The train of thoughts do come and you must not fully rely on that while picking stocks. Just going with your intuition doesn’t help.
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