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Are You Making This Big Investing Mistake?

By SiliconIndia   |   Friday, August 26, 2011   |    1 Comments
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Bangalore: Do you remember the recent swine flu scare that caused worldwide panic? An estimated 14,300 people died of this virus. If you think that's a big number, you would be surprised to note that more people die every year due to seasonal flu. But even then, swine flu has caused much greater panic than the regular flu. What could be the reason for that? Or consider the following example. In the months after the September 11 terrorist attacks in the US in 2001, travellers made the decision that travelling by car was a far safer way than by air. In light of the recency of those air attacks, this decision seemed an obvious and wise one. After all, at 'that' time, it was far easier to imagine something bad happening when travelling by air than travelling by a car. Forget cars, more people are killed every year from attacks by donkeys and by drowning in swimming pools than those who die in plane crashes! But just after a plane crash, or a virus scare, we give more prominence to those killers than anything else. So what is the reason for that? The answer again lies in our minds. These cases suggest the prevalence of what is known as "availability bias". Psychologists define availability bias as a phenomenon in which people predict the frequency of an event based on how easily an example can be brought to mind. This phenomenon was first reported by psychologists Amos Tversky and Daniel Kahneman, who also identified the representativeness bias. Availability bias is created largely due to widespread and extensive media coverage of unusual events, such as swine flu or airline accidents, and less coverage of more routine, less sensational events, such as common flu or car accidents. For example, when asked to rate the probability of a variety of causes of death, people tend to rate more 'newsworthy' events as more likely because they can more readily recall an example from memory. So a recent plane crash invokes fear of flying. This is despite the fact that, as per a study done in the US, the chances of a plane crash are roughly 6,000,000 to one, or 0.00002 percent! On the other hand, you are about 65 times more likely to die in your own car than in a plane! But since the 'availability' of news on one plane crash is much more and extensive than hundreds of fatal car accidents, the former invokes a greater fear. In simple terms, due to availability bias, the more vivid and easily imaginable a risk is, the scarier it feels. Availability bias in stock market investing Availability bias applies well to investing in the stock markets. Stocks that are followed by more analysts have higher trading volumes. Stocks that are talked about more on business channels rise and fall more than other stocks that do not gather such sound bites. Investors (like analysts) tend to believe there are more chances of stocks falling down just after a crash. And the stock prices are rising, everyone and his mother is betting that the bull market is back! If you remember the recent past, you might recollect the hype surrounding the IPOs of Reliance Power (2008) and Coal India (2011). Remember how much attention investors paid to these stocks just because these were everywhere in the media. How these stocks have performed after their listing is not a point of discussion here. But just the fact that investors were willing to go head over heels on these stocks just because they were hyped by media and analysts validates the effectiveness of availability bias in stock market investing. How to win over availability bias? When you are surrounded by a frenzy relating to a particular stock, and especially the one that you already hold in your portfolio or are planning to buy, there are a few initial things you can do to get over the anxiety. 1. Turn off your business channel. 2. Stop reading the newspaper. 3. Stop talking to your investor friends and brokers. 4. Go for a walk, or play with your kids. These things might seem difficult to do, especially stopping reading the newspapers. So the best way you can keep availability bias away from your investing is to go back to your investment checklist. Write down in simple words your reasons to buy or not buy a stock, and re-read this note every time you have a doubt created by excessiveness frenzy or caution surrounding that stock. As we can learn from the legendary investors, you can even turn availability bias to your advantage. You can do this by using excitement as a cue to consider selling stocks, and using fear as a cue to buy. As Warren Buffett once aptly said, "Be fearful when others are greedy and greedy when others are fearful." Be wary of following the latest market fad simply because of the availability of information. If you have read it in the newspaper, you may well be amongst the last in the market to know! (The author is Vishal Khandelwal, promoter of Safal Niveshak. Vishal, with his vast experience as a stock market analyst trains people to become sensible and successful investors. You can read his articles and reach him through http://www.safalniveshak.com/ )
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Reader's comments(1)
1: How true. Entire market is talking of how metals will fare badly this year. It may be true for copper, Lead,Alluminium etc which are at lower during last few months.
However generalizing this is not correct. If one goes to www.lme.com and check for steel proces, they have actually gone up by 20% to about 600USD now.
However steel prices are the worst hit this season. It is true that coal prices and ore prices have affected , karnataka's decision of mines would afect few mining and steel stocks but not all.
Posted by:K.N.kamath - 30 Aug, 2011
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