17 June 2008

Things to watch for trading

1. You know you're (almost) never wrong
"Big Mistakes" calls it "confirmation bias," another name for cognitive dissonance, the unconscious need your brain has to stick with what you already know as "The Truth" (even when it's secretly "planted" there by Wall Street's clever ad campaigns).
2. Your 'mental accountant' is an embezzler
Your brain loves "mental accounting." A dollar looks different "depending on where it comes from, where it's kept, or how it's spent." You spend tax refunds fast. But hang onto stock inherited from grandma. Wall Street's ad gurus know the way into your pocket is through that unconscious 98% that's manipulating your brain's "accounting" system.
3. You hate to lose more than love to win
Psychologists call it "prospect theory:" Investors hate to lose so much we often sell winners to "lock in profits." And we hang onto losers, praying for a miracle.
4. You throw good money after bad
The "sunk cost fallacy" is a favorite brain glitch. Here's a familiar example: First blunder, pay too much for a house. Second, fail to get out at the top. Third, turn down a bid because it's less than you paid. You're stuck paying down a big bad mortgage.
5. Decision paralysis, so you do nothing
How your brain labels options changes the outcome: Whether it's "one of rejection or one of selection, or whether you view it as protecting a gain or avoiding a loss." Labeling confusion leads to "decision paralysis," your brain locks up, does nothing, loses again.
6. You don't sweat the small stuff
With "bigness bias" you ignore small numbers like brokerage commissions and fund fees. Big mistake: This is why more Wall Street bankers, brokers and fund managers own more yachts and make 10 to 100 times more than the average clueless investor.
7. You focus on things that matter too little
Like a cruise missile, your brain locks on "anchors," specific events that looming big in your brain, blinding you to important stuff. If you focus too much on a major catastrophe like the Dot-com Crash, you might ignore the power of compounding and dollar cost averaging in building long-term wealth.
8. Your biggest saboteur, overconfidence
The investor's biggest mistake: You think you know more than you do, have all the skills to beat the averages. Wrong: You're no match for the high-tech quant-traders buying and selling millions all day long. They get information long before you or the press gets it.
9. Follow the herd, into the sea
The trend is not your friend! Yet you insist on following the momentum of the other sheep, when knowing they're also being manipulated. You buy at the top, sell at the bottom, losing at both ends. And Wall Street gets rich off your naïveté.
10. Yes, you can know too much!
Information overload is a killer, confusing your brain. In his bible, "Advances in Behavioral Finance II," Prof. Richard Thaler admits Wall Street "needs investors who are irrational [and] woefully uninformed." Wall Street's goal is to keep you that way. They pander to your delusions of superiority because that makes you vulnerable.
11. Joke's on you, knowing new rules makes brainwashing easier
This is the most amazing reality of all: Since 1954, with all the brain profiling in great books like Belsky and Gilovich's, with Kahneman's Nobel Prize exposing Wall Street's myth of the "rational investor" ... today investors are even more willing to let Wall Street take advantage of them, making Wall Street richer.
Investors live in a self-induced trance-world ... that's why neuroeconomics is called "Brainwashing 101 for Dummies!"

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