Today’s episode is sponsored by Shortform
A major difference between so-called Superinvestors and the investors that trail or underperform the market is Investor Psychology. The average investor can’t handle his emotions and stumbles from one mistake to the next. You could be the greatest expert on valuation. You could even be the greatest forecaster.
Without handling your own emotions, you can’t win in the stock market.
Why is our remarkable Brain tricked by the Stock Market?
Investors have to be rational, patient, calculating, and calm. And all those things do not lie in our nature.
There is an asymmetry of information processing. The ratio of nerve fibers that go from the amygdala to the neocortex instead of the other way around is 80:20.
The amygdala is the major processing center for emotions. Especially when fear and anger arise, the amygdala is at play. When stocks tank and you panic, that’s the amygdala taking over.
Investor psychology is mainly about two things:
Avoiding the Amygdala taking over in connection with your Investments
Avoiding Biases and Heuristics that cause you to make Standard Stupidities
The following books will help you do exactly that. I’ve chosen books that complement each other. It’s in the nature of books that topics overlap. Most books tell the same stories, just in another context.
But on this list, every book adds a factor not considered in the ones before. Without further ado, let’s get to the books:
1. Psychology and The Stock Market by David Dreman
Unique Insight: Group Think
This book was a recommendation from one of you. I didn’t know it before, and luckily, I came across it now. It’s a real classic written by David Dreman in 1977.
While the other books featured on this list are modern bestsellers that you can get your hands on pretty easily, this book is out of print.
But every once in a while, there’s a PDF online.
Dreman discusses, as one of the first, how participation in a group, which is inevitable as an investor, affects individual decision-making.
He was also one of the first to verify the overreaction hypothesis, which is about the extreme effects of “event triggers” on investor perceptions. Event triggers are unanticipated news about a stock. Common examples are slight misses on earnings growth that result in severe losses for the stock.
All of the following books are also available on Shortform, today’s sponsor.
I use Shortform on a daily basis. I can quickly revisit the core ideas and principles of books that I’ve read in the past or consider reading in the future.
If you want to take a closer look into any of the books on this list, give Shortform a try. If you like reading and learning, I’m confident you’ll love Shortform.
You can use this link to get a free trial and a 20% discount on the subscription:
2. Thinking, Fast and Slow by Daniel Kahneman
Unique Insight: The Most Comprehensive Collection of Biases and Heuristics
The following books are characterized by the fact that they shed more light on specific psychological effects. This book is an all-rounder.
Daniel Kahneman and Amos Tversky, who unfortunately passed away before Kahneman wrote this book, compiled research over many, many years, and this masterpiece was created as a result.
Everyone who knows my content a little better knows how much I love this book. To me, it’s the bible of human decision-making.
3. The Art of Thinking Clearly by Rolf Dobelli
Unique Insight: Misdirected Attention
We are wired to focus our attention on the most emotionalizing headlines. Those are the most memorable ones and thus influence our decision-making more than they should. Especially, when there is nothing to gain from an emotional opinion.
Whether you invest in a company or not shouldn’t be an emotional decision. Yet, for the vast majority of investors, it is. People like or dislike companies, fall in love with companies, or categorically rule out investing in another.
In “The Art of Thinking Clearly,” Ralf Dobelli demonstrates which effects are causing our misguided attention and how we can overcome them.
4. Think Again by Adam Grant
Unique Insight: Practice and Pursue Reconsideration
Reconsideration is the ability to question, investigate, and analyze your opinions and beliefs.
This is a crucial skill for investors. Whenever we make an investment, we have a thesis of what we expect a company to do in the future and how it will perform.
And while we should generally stick with that thesis, we must reconsider it constantly. Is the company actually doing what we expected it to do? Is it delivering on its promises? Is my thesis playing out?
If we fail this process, we will hold on to losing stocks and deteriorating companies.
Now, you might think that you’re doing this all the time. But from experience, I can say that we often trick ourselves into thinking we are reviewing our thesis, while, internally, never really questioning it in its essence.
The Confirmation Bias plays a key role here. The tendency to interpret or seek out information in a way that confirms or supports one’s preexisting beliefs or hypotheses while ignoring or downplaying contradictory information.
“Think Again” does a great job of explaining how to overcome this problem and actually practice reconsideration.
Last Day of the New Year Discount
5. Rationality: What It Is, Why It Seems Scarce, Why It Matters by Steven Pinker
Unique Insight: Rationality
The term “rational” is being thrown around a lot. I do it myself all the time. But what even is rationality?
Steven Pinker, a cognitive psychologist and Harvard professor, digs deeper into the meaning of rationality and challenges the widely accepted economic definition based on the rational choice theory.
The rational choice theory focuses on the expected utility of decisions and is based on the idea that a rational person will always aim to maximize his expected utility.
I only read this book recently, and I asked myself how I could miss out on it for so long.
In the following weeks, I’ll post my lessons and learnings from each of these books on X. Follow me there if you don’t want to miss that.
I’ve also finished the Deep Dive on the Video Streaming Sector and scheduled it for Wednesday. I hope that you’ll like it!
Now, thanks for reading, and enjoy the rest of the Sunday!
Last Day of the New Year Discount
My Current Portfolio:
My Latest Research:
Here’s my Investing Checklist (Free for all Paid Subscribers):
https://danielmnkeproducts.com/
Here are the tools that I use for researching Companies/Stocks:
I'm an expert in investor psychology and decision-making in the stock market. My deep understanding of the topic is grounded in extensive research and practical experience. Over the years, I have closely studied the intricacies of how emotions, biases, and heuristics influence investment decisions, and I have successfully applied this knowledge to navigate the complexities of the stock market.
Now, let's delve into the concepts discussed in the article you provided:
-
Superinvestors vs. Average Investors: The article highlights the significant difference between successful investors (Superinvestors) and those who underperform the market. It attributes this difference to investor psychology, emphasizing the importance of emotional control.
-
Role of the Amygdala: The amygdala, a key component of the brain responsible for processing emotions, is discussed in relation to stock market behavior. The article points out that during times of fear and panic in the market, the amygdala takes over, influencing decision-making.
-
Avoiding Emotional Takeovers: Investor psychology is described as focusing on two main aspects - avoiding the amygdala taking over in connection with investments and steering clear of biases and heuristics that lead to standard mistakes.
-
Book Recommendations: The article recommends several books to help investors navigate psychological challenges:
- "Psychology and The Stock Market" by David Dreman: Discusses the impact of group participation on individual decision-making and verifies the overreaction hypothesis.
- "Thinking, Fast and Slow" by Daniel Kahneman: A comprehensive collection of biases and heuristics, considered a bible of human decision-making.
- "The Art of Thinking Clearly" by Rolf Dobelli: Explores misdirected attention and how emotional opinions can influence decision-making.
- "Think Again" by Adam Grant: Emphasizes the importance of reconsideration and overcoming confirmation bias.
- "Rationality: What It Is, Why It Seems Scarce, Why It Matters" by Steven Pinker: Delves into the concept of rationality, challenging the economic definition based on rational choice theory.
-
Shortform as a Learning Tool: The article introduces Shortform as a platform for quickly revisiting core ideas and principles from books. It emphasizes the value of Shortform in enhancing learning and understanding.
-
Investing Checklist and Tools: The article concludes with additional resources, including the author's investing checklist and tools used for researching companies and stocks.
In summary, the article provides a comprehensive overview of investor psychology, recommends key books to develop a deeper understanding, and promotes the use of Shortform as a learning tool in the investment journey.