How do humans learn anything? Through feedback loops. Imagine you are riding your bike and getting late for the office – you don’t see any traffic cop at the red light… and you jump it. There was an incentive and an opportunity. A few hours later, you get a challan message. There was a camera that caught you. The next time you won’t dare to jump the red light as you already got feedback from your previous misadventure. Similarly, if you, as a good Samaritan, helped a blind man cross the road, you will instantly feel good for the deed.
Sportspersons make excellent use of feedback they receive when they make a right move or a wrong move. A tennis player who keeps hitting the net while playing a backhand topspin, instantly realizes that she has to practice it more while training.
Unfortunately, in investing, it is risky to rely on feedback.
You buy a stock and the next day the market falls and takes the stock down with it. Does it instantly become a bad investment? A long-term approach is critical for most investments to succeed.
There are a dozen reasons for markets to go up and many times the same reasons for them to fall. But feedbacks are most useful when the link between our actions and results is clear. A stupendous 25% GDP growth takes the market down just because the street was expecting an even higher number. In investing, the instant results of any action can be highly misleading. Over short time horizons, meaningless noise dominates outcomes.
Learning from short feedback loops only works if the impact of negative feedback is minor. You know that drinking poison will kill you. You don’t have to verify it by consuming it and facing its consequences. Similarly, we already know the risks involved in taking concentrated stock positions, borrowing money to invest in the stock market, and putting money in an unregulated instrument like crypto. The negative consequences of these won’t count as lessons after facing catastrophic losses.
Investors learn from their own experiences and the experience of others. Our sample size is simply too small. And hence, it is far too easy to learn the wrong lessons.
Here is a short, non-exhaustive list of things to remember:
- Ignore near-term feedback as much as possible.
- Decide what type of feedback is useful.
- Learn the right things from the right people.
- Weigh evidence correctly.
- Focus on general principles rather than specific stories.
In investing, useful feedback is often received too late because meaningful results only emerge over time. Investing is an exercise in dealing with short-term noise, deep uncertainty and profound behavioural challenges. The best we can do is base our decisions on sound principles, always be willing to learn and understand that most short-term feedback can be ignored.
With excerpts from www.behaviouralinvestment.com
Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered investment advice or research recommendation. The users should rely on their research and analysis and should consult their investment advisors to determine the merit, risks, and suitability of the information provided.”