Never, hasn’t, can’t and won’t are all words that stem from a lack of imagination of what can happen. We must first recognize that words like these are rooted in biases and are often the reason we fail to learn from the past and our past mistakes. We create plans to mitigate these biases and overcome them.
If someone has not experienced or studied a specific type of historical adverse event, their frame of reference may be too small. The word hasn’t is frequently accompanied by instances like this, which can lead to inadequately incorporating probabilities of a move taking place. Eventually, it will lead to an unexpected gain or worse, a sudden loss. Wide frames of reference help expand our imagination as to what is possible so that we can more appropriately plan for what may come in the future.
We should also be cautious when investment ideas come to mind immediately. Often it is because we have only recently read or heard something about it. In most cases, this availability bias is compounded further by the fact that what we have read or heard parallels our own situation. In addition to incorporating this new knowledge when planning, we need to search more deeply for other information and opposing points of view. The word never might then be more precisely used.
Nowadays many retail investors participate in day trading due to a belief that they won’t lose money. These same investors tend to believe that they have more influence over an investment than they actually do. This coupled with a lack of self-control can and does lead to over-trading. For investors with the ability to partake in alternative investments like hedge funds, their inherent structure stops the biases that lead to short-term trading. For instance, it is a popular practice for hedge funds to institute initial lockup periods, gates, and penalties to prevent selling before an investment has had time to fully mature.
Another particularly dangerous bias is adhering to the “status quo” and not taking any action. When people get married to a position, they often exhibit a lack of inertia and fall victim to this bias. This type of emotional bias can be especially damaging in periods of shifting regimes. The word can’t is partially attributable to failures in the realization that the context has changed. In these situations, continuing to do what has worked in the past will lead to underperformance or even loss.
It is easier to correct a mistake due to faulty calculations rather than one that stems from an emotional predisposition; nevertheless, it is essential for us as investors to recognize our biases. Once we are aware of them, we can start to put measures in place to correct them, so that we learn from past investment and trading mistakes. Maybe it is due to my availability bias, or perhaps Nassim Taleb just said it best, “history teaches us that things that never happened before do happen. It can teach us a lot outside of the narrowly defined time series; the broader the look, the better the lesson… If the past, by bringing surprises, did not resemble the past previous to it, then why should our future resemble our current past?”.
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