High Yield Can Be a Trap

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Crypto-currencies are dominating the story lines as they should. Not only is Bitcoin ramping up to new highs, many companies, including publically traded companies, are loading up. MicroStrategy MSTR is one of them and it has been amongst Crave Investor's highest ranked stocks. But crypto isn't driving the financial bus. 

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There is a market that is the tsunami in the financial markets. It's the bond market, i.e. interest rate markets, and it's known as "the wise one"! 

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Rising rates usually hurts the stock market while falling rates ,declining cost of money, fuels up trends. It doesn't have to be that way but it usually is. 

This isn't finished yet; taking a break to provide an update for subscribers with key markets info an actionable info. Stuff for driving your online portfolio. Back shortly. 

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When to fold... 

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This is a partial excerpt from "When to sell your stocks" from The Economist. It is posted for the purpose of educating our subscribers. This page, aptly titled Behavioural Finance, is here as our observation is our personal tendencies often have a bigger impact on how an investment is handled than the market itself.  Some of what we thought were key points are highlighted (in red). 

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Watch professionals play poker, and one of the first things to strike you is how often they fold when the game has barely begun. Rounds of Texas Hold’em, a popular variant, start with each player being dealt two cards and then deciding whether to bet on them. Amateurs are more likely to proceed than not, while pros fold immediately up to 85% of the time. Naturally this does not mean that high-stakes casinos are frequented by the timid. It is simply that most hands are too likely to lose to be worth betting on, and the pros are better at judging when this is the case.

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Investors usually dislike gambling comparisons. Yet at a recent conference held by Norges Bank Investment Management, which oversees Norway’s oil fund of $1.6trn, a packed hall sought to learn from a former poker pro. Annie Duke was there to talk about quitting decisions, a topic on which she wrote the book (“Quit: The Power of Knowing When to Walk Away”). Ms Duke argued that many factors stack the deck against people considering quitting, pushing them to act irrationally. That applies to poker players wondering whether or not to fold—and also to investors considering whether to exit a position.

Selling out of a position is much harder to do well than buying into it. To see why, start with some now-famous biases popularised by Daniel Kahneman and Amos Tversky, two giants of behavioural science on whose work Ms Duke draws. People hate losses a lot more than they enjoy equivalent gains (“loss aversion”) but reserve a special loathing for crystallising a certain loss, even if the probable alternative is a greater one (“sure-loss aversion”). They also value things they own more than identical things they do not (the “endowment effect”). All this makes closing a losing position an absolute wrench. Already smarting from a paper loss, you must turn it into a certain one, while also letting go of an asset you value more than you would any equivalent alternative.

Small wonder retail traders are bad at this. Alex Imas of the University of Chicago has studied the behaviour of those who set take-gain and stop-loss orders when they enter a trade. Although these are supposed to neuter harmful biases by exiting the position if a specified profit or loss is reached, Mr Imas found that few investors reached their take-gain orders, having already sold manually rather than risk their profits disappearing. Meanwhile, they tended to cancel and blow through their stop-losses, preferring to keep gambling rather than take a certain hit.

Are the pros any better? Only up to a point. Last year Mr Imas and colleagues published a paper on the buying and selling choices of 783 institutional portfolios with an average value of $573m. Their managers were good at buying: the average purchase, a year later, had beaten the broader market by 1.2 percentage points. But they would have been better off throwing darts at the wall to select which positions to exit. After a year, sales led to an average of 0.8 percentage points of forgone profit compared with a counterfactual in which the fund selected a random asset to sell instead.

Unlike retail traders, the pros were not clinging on to losers. Yet neither were they making selling decisions analogously to how they make buying ones: by choosing the asset adding the least to their risk-adjusted return and offloading it. Instead they used a simpler heuristic, disproportionately selecting positions where relative performance had been very bad or good, and exiting those. As a result, they were throwing away two-thirds of the excess returns their skilful buying had won them.

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Reprinted from The Economist. 

                                                                                                                                        

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