Studies of Life

Learning by doing.

A conditioned investor is not the same as a wise investor

05 October 2015 by Jim

I’ve stumbled across an excellent article on the Philosophical Economics blog.

Instead of just collecting interesting investing articles in my notes (Evernote) as I did until now, I think it is more worthwhile to actually use the knowledge gained from my reading and ruminations to create a kind of personal guidebook for investing.

I will maintain an essential reading list here on this site for anybody who’d like to read some good articles or books on the topic of investing, alongside a short commentary on each so you can easily figure out of an article or book is for you.

My personal summary of the article above is this:

Prices trend because the underlying fundamentals of stocks do as well. When the economy is expanding, there may be many underlying factors all moving in the same general direction, so the fundamental evolution of next month is dependent on the one this month. The evolution of the economy and different underlying factors is thus not at all random. This trending phenomenon is reflected by prices, which also trend in response to this. The reaction to new information about a stock is not instantaneous, because assumptions and risk appetite change considerably over time, depending on short-term conditioning. When investors experienced a huge drawdown they will be fearful, and only repeated positive developments will change their outlook, by making them unlearn their previous risk-aversion. This is Skinner’s behavioural theory. These two major phenomena should be evaluated when making decisions as an investor, by asking two important questions:

  • What is the fundamental trend in the asset we talk about?
  • What is the conditioning of the market participants now looking at this asset?

A useful practical technique to avoid being paralysed by your own conditioning is to make small bets. When you think conditions are changing, make a small bet on it. If that bet turns out be correct, you will be conditioned into repeating that behaviour, thus using the technique of conditioning to ease you into a new market view. If it’s not correct, you haven’t lost much.

The author of the article notes that conditioning is very different from learning something. Since the evidence gained from whatever happened in the stock market is temporary in nature and not indicative of a permanent truth, it can hardly be called learning. This is a useful distinction to make regarding any kind of learning.

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