All in a day's work

What is Gambler's Fallacy?

Am i having a traits of a gambler in my investment decisions


Gambler's Fallacy, in Behavioral Finance, is the belief that if deviations from expected behavior are observed in repeated independent trials of some random process then these deviations are likely to be evened out by opposite deviations in the future.

This simply means this:

If a coin is tossed repeatedly and heads comes up more often than tails, a gambler may incorrectly believe that heads is more likely to appear in the future. But as a matter of fact, a coin has two sides and the chance of heads or tails is always 50-50.

An experiment carried out by Amos Tversky and Daniel Kahneman shows that people see (streaks of) random events as being non-random when they are actually much more likely to occur in small samples than expectations.

In relation to investing:

Do you gamble on the bottom more often at the start of a certain drop?
Have you considered the reasons of an entry/exit or are you just hopeful?
Do you see IPO as a sure-win opportunity?

Make sensible decisions based on analysis and not hear say or gut feeling as regret on a loss is always a worse feeling that the joy of a profit, Loss Aversion.

What is Loss Aversion in Behavioral Finance?

First and foremost. I am not a guru in this area but I've been interested in this for some time and did some readup. My posts on this topic, for sharing, might be fairly shallow and critics would be apppreciated.

"Behavioral finance is a rapidly growing area that deals with the influence of psychology on the behavior of financial practitioners."

"Behavioral finance is the application of psychology to financial behavior—the behavior of practitioners."

"Behavioral finance is the study of how psychology affects financial decision making and financial markets."Shefrin (2001)

For a while, theoretical and empirical evidence suggested that CAPM, EMH and other rational financial theories did a respectable job of predicting and explaining certain events. However, as time went on, academics in both finance and economics started to find anomalies and behaviors that couldn't be explained by theories available at the time. While these theories could explain certain "idealized" events, the real world proved to be a very messy place in which market participants often behaved very unpredictably.

Important Characters to BF:

Daniel Kahneman and Amos Tversky

• Fathers of behavioral economics/finance in the late 1960
• Published about 200 works, relating to psychological concepts with implications for BF
• In 2002, Kahneman received the Nobel Memorial Prize in Economic Sciences for his contributions to the study of rationality in economics
• Focused much of their research on the cognitive biases and heuristics that cause people to engage in unanticipated irrational behavior.

Richard Thaler

• This field would not have evolved if it weren't for economist Richard Thaler.
• During his studies, Thaler became aware of the shortcomings in conventional economic theoryies as they relate to people's behaviors.
• After reading a draft version of Kahneman and Tversky's work on prospect theory, Thaler realized that, unlike conventional economic theory, psychological theory could account for the irrationality in behaviors.
• Thaler went on to collaborate with Kahneman and Tversky, blending economics and finance with psychology to present concepts, such as mental accounting, the endowment effect and other biases.

The presence of regularly occurring anomalies in conventional economic theory was a big contributor to the formation of behavioral finance. These so-called anomalies, and their continued existence, directly violate modern financial and economic theories, which assume rational and logical behavior.
Examples of Anomalies: The Winner's Curse, January Effect, Equity Premium Puzzle and etc.

Conventional financial theory does not account for all situations that happen in the real world. This is not to say that conventional theory is not valuable, but rather that the addition of behavioral finance can further clarify how the financial markets work.

It has been a long time since I last posted and I wonder if my site is still being visited.

But nevertheless, I will be posting on a series of posts about something in Behavioural Finance. Something which I think will help everyone understand a little bit more about themselves in their investing journey.

This series of posts will be done and completed by End Feb. I am expecting to post about 10 posts which will be completed by end Feb, early March.

So stay tuned!

This post is just to bring about some thoughts to the current situation which hopefully some of you might find interesting.

1. The first huge spike from the left of the chart on 1929.

Right before the run-up, we can see some resistance from 1900 to 1926 before a bull run that ended in 1929. This run increased Dow Jones by a good 138% within 4 years.

That spike happened in 1929 before it collapsed to 44.17 points, this also meant that within 4 years, Dow Jones lost almost 89.2% of it's value.
I stress again, 89.2%.

2. The recovery from 1929.

If an investor added a position at the peak of the bull run on 1929, he would have to wait 30 years before he managed to break even, not considering the dividends that he might received throughout the entire holding period.

This once again stresses the importance of entry price for long term holding as it determines the yield thereafter from divvy.

After the recovery to it's previous high which took 30 years, the stock market tanked for almost another 30 years, from 1958 - 1986 thereabout.

3. The break of the 1000 mark and beyond

This historical peak of 1,000 was finally breached around 1983. This is the start of a monstrous run which was never seen in history.

Since 1983 till 2008, a period of 25 years, Dow Jones not only broke the 10,000 mark but in fact hit 13,930. In 25 years, Dow Jones increased 1393%.

Once again, I repeat myself, in 25 years, DOW JONES went up 1393%.

A few questions which I think can be pondered on would be:

1. Did the economy improve so much in the last 25 years to warrant such an astronomical increase, if we consider that the saying of the stock market being a reflection of the economy is true.

2. What then could be the reasons for such a sudden increment in Dow Jones

3. If PE ratio is a reflection of the investor's confidence in the company's future earnings, what motivated them to push PE ratios upwards

4. What causes Dow Jones to lose almost 90% back in 1929 (This can be easily found online, just google it.)

5. Lastly, will this be a repeat of 1929 or rather, has the run-up been way too strong to be justified by current share prices implying room for further drop, back to the times when the stock market reflects the economy in that time.

Here is my view on the million dollar question. First let us take a look at the property cycle.

There is a constant opine throughout that property lags the economy as an asset class. Even recently, we can see this trend even in Singapore. There was a good run uptrend in the economy and property prices started rising till the point when everyone was saying that it's too expensive. Then "BAM!", we all know what happen after this. Now property prices are coming back down again. A boring cycle indeed, but can you identify with it? Are there lessons to be learnt?

Why then does the property lags the economy.

A booming economy will bring in the monies to the bank and for this to happen, time is required. When everyone seems to be very comfortable with the amount of money set aside, they look to invest in the most physical asset, property. When the demand increases, prices increases. It's normal. A property asset require a huge amount of money and housing loans would normally be subscribed for their very purpose. This result in a man laden debt, who still holds the positive mindset that the good economy will last. When a crisis hits long enough for everyone to realise that the good times are gone, a primitive man's psychological reaction would be to protect himself and his needs, thus the demand for property drops resulting in the drop in property prices/value. This will generally also cost a reduction in expenditure in the economy throughout.

How does that relate to a bottom then.

In a crisis like this, companies bankrupt and employees retrenched. Both these incidents will have negative effect on the economy but the time before the impact is felt also require time. This I think is pretty easy to comprehend and I won't spend too much time explaining. In 2H2008, we see the liquidation of banks and retrenchment of staffs and at the start of 2009, more retrenchment news (Alcoa)and liquidation of operations (LyondellBasell) was announed.

If companies are not making profits and unemployment rate is high worldwide, why is there a good reason for a rebound or rather, should any rebound be taken seriously and result in you jumping into a position?

Although I also know that it's been said that share prices are at their lowest even before the economy shows it. (I forgot the term used to relate this but try to understand.. haha!) But do you think things might be rosy again soon? If so, how soon?

Share with me your thoughts!

Toyota is one of the best-run companies in the world. Much of its success is due to "lean thinking," a concept that aims to create additional value for the end customer, according to Mike Morrison, Dean of Toyota University

I was rather shocked when I heard this news over the TV, not by the fact that such a decision was made but the length of time it has decided to stop it's production. That's effectively 1/3 of a month !! Can your company stop production for 11 days ?

Obviously, this recession has effectively affected Toyota that it has decided to make such a drastic move. By the way, Toyota is considered world wide as one of the few companies which has a fantastic culture and management system. Just look at their rise to their current status.

Toyota Management Style is influenced by Taiichi Ohno, who developed the Toyota Production System. Quote: "I feel strongly that the word 'work' refers to the production of perfect goods only. If a machine is not producing perfect goods, it is not 'working'."

• Many of you till now may think that this is just another IDEAL but Personnel in the production line has the power to halt the production when malfunction occurs.

Toyota Coporate Strategy: “Cut down on the distance that things move throughout the plant.”

Toyota Strategic Management: “Utilise the inherent talent of your workers.”

Toyota Leadership Model: "Never fail to reward merit, but never let a fault go unremarked."

To know more about Toyota: The Toyota Way - Jeffery K. Liker

This company has been on my list for the longest of time and 'm not going to give it up yet for other companies despite it's drop from $0.50+.

Here, I'm not going to have a story telling session on this company but just something short and sweet for sharing purposes on TA since it's really been some time since I last posted.

As seen from the charts, downtrend is still intact although it broke out from it's first trend but still, it's within the bigger trend. Not a good sign yet.

However, there is one thing that is worth of note. Courage Marine is currently heading to it's latest low of $0.11. Could that be a time to buy, personally yes. But then again, the economic conditions is definitely not recovering in the mean time and could in fact, worsen. The earnings of this company is dependent on the BDI, a future economic indicator, which may not be heading north in the coming days/weeks. Another point worth pointing out is the increased selling volume experienced in the last 3 days, definitely not something encouraging.

Technicals aside, this company has yet been through a major economic crisis since it's founding in June 2001. So this is the time to observe if this company has the right personnel to bring the company into a better era. So unless everything starts to show signs of settling, and my dear company manage to survive, I will definitely buy in.

For 3Q2008, CM has managed to nett a US$38.9m profit, a flattish profit as the management puts it, considering the oil rices and all the nonsense in recent months, personally it is not all bad. This is due to the tight financial controls by the management, credit to them. Another point which I like about CM is the $0 debt and all it's net assets are backed by cold hard cash, which the mangement can utilise to increase gearing to avoid cashflow issues.

Lastly, something interesting to point out is that in current times, CM has signed an agreement to buy one additional vessel.

I've yet to drill the report partly because I'm still waiting for the full FY08 AR where it will be clearer the impact the economic conditions has on CM.

Till then........ Cheers