In life, we focus more on winning, surviving rather than failure. This illusion kills our ability to calculate the probability of surviving, success. We cannot see that probability of success can be very small. We always taught about success and not taught about failure. This is known as a survivorship bias.

Many authors write a book but a few will achieve success. Thomas Edison failed many times before inventing of the bulb but today, we only remember with their success, survivor.

“I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times I’ve been trusted to take the game-winning shot … and missed. I’ve failed over and over and over again in my life. That is why I succeed.” ~ Michael Jordan

Investment – Similarly, very few have achieved success in the investment world but we overestimate the probability of success and ignore to look that many have spoiled their life. We focus on successful companies which have created a lot of wealth. When we visit any seminar or marketing people or media, they only talk about the successful companies which have created wealth but never talk about companies which have eroded wealth. Wealth creators are very few compared to wealth eroded. But we ignore the probability of losing and never try to learn from others mistakes. We all come to the stock market for becoming a next Mr Buffett but does not focus on developing ability and insights as similar to Mr Buffett & Mr Munger.

There are ~7000+ companies got listed on Indian bourse from that ~4294 companies are down almost 80%+ (many companies got unlisted or close) whereas we know that few companies which have generated wealth over a period. So ~60% of wealth destroyers are there compared to hardly ~3% wealth creators (maximum- if we see actual wealth creators for long term then that is ~1% only).

We can see that there are huge wealth destroyers companies available compared to few wealth creators. So that while investing don’t try to catch every opportunity available but prepare investment philosophy suitable to us, swing bat only when the suitable opportunity arrives. We need to prepare investment philosophy, process, circle of competence and investment style so that we can swing bat when things fall under our zone.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

05 – Illusion

Illusions of Remembering

The illusion is not only of visual but it’s also of memory.

If we have seen any words or something for even a millisecond then also when we see it again we feel it familiar. Something which is in contrast to others that also give us a feeling of familiars. This creates a memory illusion.

Illusions of Truth

When things seem familiar, we generally tend to accept it as truth. But when things seem unfamiliar or extreme then we tend to reject it.

The impression of familiarity is produced by System 1, and System 2 relies on that impression for a true/false judgment.

When we wanted something to accept by people as truth then we keep on repeating the same. Because familiar things are easy to accept as truth.

When we listen frequently that equity investment or real estate investment can help us to create wealth then we become familiar to it and we start believing it as a truth. When we see people surrounding us making money through trading then we also believe it as a truth. We also start doing it without thinking about it as a truth or not. It keeps getting repeatedly visible in front of us and we believe it as a truth.

How to Write a Persuasive Message

When we write something truth but it is not necessary that people also believe it as a truth. For that, we need to use a true illusion. We need to draft our writing in a good manner, with proper colour combination and do not make it very complex, make it memorable.

Strain and Effort

The performance was better with the bad font. Cognitive strain, whatever its source, mobilizes System 2, which is more likely to reject the intuitive answer suggested by System 1.

The Pleasure of Cognitive Ease

Companies with pronounceable names correctly better than others for the first week after the stock is issued, though the effect disappears over time. Stocks with pronounceable trading symbols (like KAR or LUNMOO) outperform those with tongue-twisting tickers like PXG or RDO —and they appear to retain a small advantage over some time.

Ease, Mood, and Intuition

Our mood has an impact on system 1 and intuition. When we are uncomfortable, suspicious and unhappy, we lose touch with our intuition. And our system 2 take control. Reversely when we are happy, comfortable then system 1 take control.

So that we need to understand our mood while making any investment decision. If we are in good mood then our system 1 will take charge and we might not be getting involved in the proper analysis of our own decisions.

Norms, Surprises, and Causes

Assessing Normality

The main function of System 1 is to maintain and update a model of your personal world, which represents what is normal in it. The model is constructed by associations that link ideas of circumstances, events, actions, and outcomes that co-occur with some regularity, either at the same time or within a relatively short interval. As these links are formed and strengthened, the pattern of associated ideas comes to represent the structure of events in your life, and it determines your interpretation of the present as well as your expectations of the future.

When something happens or surprise our first time, when similar happens again, we will get lessor surprise or treat it as a normal. Our system 2 suggest that this is not a normal but system 1 made it. Whenever we met any surprises for the first time, our mind expects similar to happens again while a similar situation arises. That previous incident becomes normal for us and if that similar incident will not occur then we get more surprised.

It has been previously happening that market falls and get recover from that fall within 1-2 years. So that when the market falls everyone thinks that it will recover easily and we should invest. But there is a possibility that it may take a longer time to recover then what it used to be in past. So that we should not believe blindly that what has happened in past can happen in future also. It can have a higher probability to happen similar but also should not ignore the probability to not happen the same again or in the same time period.

Seeing Causes and Intentions

We generally use casual intuition frequently. For example, if someone says that he lost his wallet, then first thought comes of pickpocket rather than put somewhere, forget at restaurants, etc.

A Machine for Jumping to Conclusions

Jumping to conclusions is efficient if the conclusions are likely to be correct and the costs of an occasional mistake acceptable, and if the jump saves much time and effort. Jumping to conclusions is risky when the situation is unfamiliar, the stakes are high, and there is no time to collect more information. We should not jump to the conclusion where we know that involvement of system 2 is essential. It has a higher probability to meet error if we jump to the conclusion without taking the help of system 2.

04 – Intelligence, Control, Rationality

Intelligence, Control, Rationality

One research is done on the four-year-old children. They have given one marshmallow and told them to eat it anytime but if they wait for the 15 minutes then they will get one more.

Video of marshmallow

Ten or fifteen years later, a large gap had opened between those who had resisted temptation and those who had not. Those who show higher self-control, those also have scored higher in intelligence test during the adult time.

Stanovich has talked about two minds of system 2. One of these minds (he calls it algorithmic) deals with slow thinking and demanding computation. These measures calculation skills and intelligence. Second is rational thinking.

The Associative Machine

When we listen or see or read something disgusting than our mind immediately connects it and start preparing pictures of it. The mind will start associating a word with many different elements and we temporarily fall under those emotions. If we have heard the highway accident, then our mind starts preparing some pictures, incidents of it and we stay away for some period from it. This concept is known as associative activation.

These responses occurred quickly, automatically and effortlessly. System 1 shows those words as a reality and our body starts reacting on it. These words activate some thoughts, that activates other thoughts. When we have read or listened to the news of recession in the automobile industry in the year 2019. Our mind starts creating an image of it so that we stay away from investing in the automobile industry. But if we use system 2 and make a rational decision then scenario can be entirely different for us.

The Marvels of Priming

When we see some puzzling things then we connect it with recent activities which we have performed or something is in our mind currently. If you have recently seen or heard the word EAT, you are temporarily more likely to complete the word fragment SO_P as SOUP than as SOAP. The opposite would happen, of course, if you had just seen WASH. We call this a priming effect and say that the idea of EAT primes the idea of SOUP, and that WASH primes SOAP.

If you were primed to think of old age, you would tend to act old, and acting old would reinforce the thought of old age. So that we behave the way we get primed.

Primes That Guide Us

Our surroundings are also responsible for build primes in us. For example, if we surrounded by money-minded people, our behaviour starts becoming money minded. What we see, listens are also affects our behaviour.

System 1 provides the impressions that often turn into your beliefs, and is the source of the impulses that often become your choices and your actions.

System 1 creates a story and system 2 believes it. So that later on it becomes our belief.

When we surrounded by short term oriented, traders mentality, lazy, etc. then system 1 starts creating a story and our behaviour starts forming like our surroundings. Thus, if you want to become an investor then you have to keep distance with people who have a trader mindset otherwise trading will get priming to our mind and we will get diverted towards trading activities.

Cognitive Ease

Whether we are conscious or not, there are lots of calculations and thinking of running in our brain. These all done through system 1. These calculations through system 1 keep on assessing various situations, survival, threats etc.

These works in a range of easy and strain.

Easy is a sign that things are going well—no threats, no major news, no need to redirect attention or mobilize effort. Strained indicates that a problem exists, which will require the increased mobilization of System 2.

Cognitive ease happens when we are in a good mood, sentence which we read is in clear fonts, proper colour, etc. and reversely cognitive strain happens when we are in a bad mood, sentence which we read are poorly written, not clear fonts, poor colour combination, etc.

When we are into cognitive ease state, we are in good mood, we believe what we hear, trust intuition, be creative etc. But when we are into cognitive strain state then we are effortful, suspicious, feel less comfortable, make fewer errors, etc. When we have invested in a particular company and the price of it keeps raising, we start staying in cognitive ease so that we do not focus on the fundamental side. Whereas when prices not raising then only people get cognitive strain and focus on fundamental parts.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

03 – System 2 efforts

Attention and Effort

System 2 is effortful and one of its main characteristics is laziness, a reluctance to invest more effort than is strictly necessary. System 2 efforts and self-control help us to overcome intuitions and impulses of System 1.

Mental Effort

For testing of our system 2, we have a game which helps us to know the efforts of our system 2. We prepare a few cards and on which we write the four-digit number. Then we pick up cards randomly and add-1 to each number written on a card. For example, if the number on the card is 1125 then answer will be 2236. We find it easier so now, we can try it with more difficulties and use add-3. That means if the number on the card is 1125 then answer will be 4458. 

Our pupils are sensitive indicators of mental efforts so whenever we put any mental efforts to think our pupil size gets change. When we start working on any problems our pupils get larger in size and as we get solutions or give up then pupil size start contracting.

Switching from one task to another is also requires mental efforts and which uses system 2.

Modern tests of working memory require the individual to switch repeatedly between two demanding tasks, retaining the results of one operation while performing the other. People who do well on these tests tend to do well on tests of general intelligence. We generally tend to break down works in a smaller part to perform it well. We generally use the law of least efforts.

The Busy and Depleted System 2

When we are putting mental efforts means system 2 is busy in thinking so that system 1 take charge of our immediate decisions. If someone asked us to select food during that time, system 1 mostly go with temptation food, go with sweet foods. There can be selfish decisions. Higher the demand for system 2, higher the self-control which is depleting and unpleasant.

Sometimes when we have put efforts in one task, we tend to avoid putting efforts on others. And sometimes, we accept to put efforts on others. When we have a strong incentive to do so.

When you are actively involved in difficult cognitive reasoning or engaged in a task that requires self-control, your blood glucose level drops. So, giving glucose to the brain helps to put more mental efforts. That’s why sweet foods, temptation foods and activities which we love to perform getting demanded when we have put huge mental efforts and we get tired mentally. These things help to give energy and rest to system 2 so that system 2 is getting ready for another mental effort. 

The Lazy System 2

Many people are overconfident in nature and also that have an overconfident on their intuition. So that they avoid taking decision by taking the help of system 2.

When people believe a conclusion is true, they are also very likely to believe arguments that appear to support it, even when these arguments are unsound.

Similarly, while making an investment, we majority times use system 1 and avoid uses of system 2. So, we reach the conclusion and accept the arguments which support our investment though it’s correct or not. Though we have invested wrongly, we do not listen to it and just seek for supporting arguments. 

Those who do not fall under such a trap and uses system 2 whenever required. They are more rational. So that we should not be biased with our investment and keep collecting information which is against our original hypothesis.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

05 – Current temptation, future frustration

The fifth part of Series “Current temptation, future frustration“. This series is based on the companies which are currently darling of the market and many trying to catch such opportunities but it has a probability to become a reason for future frustration. It can wipe out the majority of gains in wealth. I am trying to put some of the number-crunching facts by which we can identify ongoing issues in the companies and can save our wealth.

I am starting this series with one of the company which is engaged in import and export agent, representative, contractor, selling agent, the broker on wholesale cash and carry basis for metals, minerals, iron and steel products, pipes, household items, general merchandise etc, has a 52 weeks low price of Rs.4.60 and LTP is Rs.31.65. This company has rewarded ~6.88x of return in a year.

Let’s start looking at the numbers.

When we look at the balance sheet then it seems that the company does not have any issue. It has reduced all debt, also it has huge investments.

Wonderful… The company still available below investment value after 6x price raise.

Let’s go further detail.

If we look at the income then the company does not have any income available. Also, the company is traded at ~530x Mcap/sales.

So this company does not have any business. Only investment of the company is good then this situation seems similar to Bluechip stamp investment made by Sage Mr.Buffett.

Let’s check the investment.

The company has ~30% of investment into liquid assets and all others into unquoted & related party investments. 

So the company keeps giving loans to related parties. 

The company does not have enough plan assets to fund gratuity.

This entire series is based on past available data and ignored the future development in companies and the stock market always looks at the future.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.