DIY Investor Magazine
/
2015 Issue
16
These quotations from Seth Klarman, one of today’s
most respected hedge fund managers, and Jesse
Livermore, a legendary momentum trader of the 20th
century, leave nothing to the imagination. Investors
– whether private individuals or professionals –
repeatedly make systematic mistakes on the stock
market. And many of these mistakes are caused by
unconscious psychological forces that impel investors
to take irrational actions. The relatively recent academic
discipline of ‘behavioural finance’ focuses on analysing
the many psychological forces or biases that lead to
investment mistakes but decades ago, countless top
investors had already discovered the destructive power
of the human psyche, and learned how to deal with it.
In my book Excess Returns: A Comparative Study of
the Methods of the World’s Greatest Investors, I explain
how the world’s most successful investors set about
beating the stock market and how they try to avoid
the errors that other investors make. They emphasise
that successful investors (i) proceed through a superior
investment method, (ii) implement that investment
method consistently and with great discipline, and
CLASSIC INVESTMENT
MISTAKES AND HOW TO AVOID THEM – PART 1
(iii) know how to cope with all sorts of (unconscious)
psychological forces that steer them repeatedly on to
the wrong course. In Part 1we look in more detail at a
number of classic mistakes along the investment chain.
Classic Mistakes Across the Investment Chain
In figure 1, I illustrate the various steps in the investment
chain, and the steps at which things can go wrong:
STEP 1: SELECTING SHARES FOR FURTHER ANALYSIS
Investors must use their time efficiently; it is impossible
to analyse the many thousands of shares on the stock
market so intelligent investors focus their efforts in
the first place on analysing shares that have a greater
chance of being undervalued than other stocks.
Unfortunately, as illustrated in figure 1 there are a
number of (psychological) forces that steer people to
precisely the wrong shares. For instance, many people
seem to find it logical to put their money in shares that
figure prominently in the media, that do something
spectacular, that come to the market for the first time
or that are ‘hip’. Unfortunately, these sorts of shares are
often expensive or over-hyped; top investors find the
most interesting shares are actually those that people
aren’t looking at, that aren’t popular or that people
have an aversion to.
Frederik Vanhaverbeke
Excess Returns: Bond Manager at KBC Asset
Management author of A Comparative Study of the Methods of the
World’s Greatest Investors
A country of security analysts would still overreact.
In short, even the best-trained investors would make
the same mistakes that investors have been making
forever, and for the same immutable reason – that they
cannot help it.
Seth Klarman
There is nothing new on Wall Street or in stock
speculation. What has happened in the past will
happen again and again and again. This is because
human nature does not change, and it is human
emotion that always gets in the way of human
intelligence.
Jesse Livermore
