Learn to invest with Buffett

Chapter 95

Chapter 15 Section 7 Don't have irrational thoughts
In investing, people have irrational thoughts, which is predictable.The results of these thoughts are unpredictable.

--Warren Buffett
Psychology is the main factor that influences human behavior. Once money is involved, people are more likely to make emotional and illogical decisions. Irrationality is one of the most important emotional manifestations.

In his investment practice, Buffett has a deep understanding of the irrationality of investors: "In fact, people are full of greed, fear or stupid thoughts, which can be predicted. However, the results of these thoughts are unpredictable. .” 
In the incomplete marketization of the Chinese stock market, due to the lack of detailed cognition and rational thinking about the stock market, the most common investment mode in the Chinese stock market is irrational speculation such as listening to news and speculating in stocks with dealers.Shareholders do not conduct basic analysis of the companies they want to invest in at all, and buy or sell frantically as soon as they hear news.Such investors can be seen from time to time.However, despite this, many empirical studies in many professional newspapers and journals have shown that the Chinese stock market is actually effective with a large amount of data analysis.Finally, some scholars in foreign countries began to face up to the facts and study the real behavior of investors in the securities market based on reality rather than assumptions.The impact of these studies is growing, and gradually formed a new financial theory: behavioral finance.Behavioral finance theory is based on the research results of psychology on human decision-making psychology, and takes people's actual decision-making psychology as the starting point to discuss the impact of investors' irrational investment decisions on securities price changes.

Many investors habitually dislike the market that is most favorable to them, but like the market that is always unfavorable to them.When the market price rises, they feel optimistic, and when the market price falls, they feel pessimistic.What would they do if they went one step further and turned this emotion into action?Selling low and buying high is not a profit maximizing strategy.

Behavioral finance research shows that investors in reality are "full of greed, fear or stupid ideas" as Buffett said, not completely rational as assumed in the efficient market theory, but bounded rationality, and there are many behaviors Cognitive bias, which causes price to deviate from value.

If investors want to beat the market, they must ensure that they do not make irrational mistakes, and then they may take advantage of other investors' irrational mistakes to profit.If you speculate irrationally, expecting fools to appear stupider than yourself, you may end up finding yourself to be one of the dumber fools.From childhood to adulthood, we have participated in countless exams and competitions, countless successful experiences and lessons from failures, telling us: the final winner is always the smartest person, and IQ determines everything.

But after working for several years, or even decades, I feel very confused: Why were very smart people in the past not very successful?Why are those guys who are successful in their careers but ordinary people that we don't even look down on?
People who have been investing in stocks for several years will be even more confused: Why are there so many fund managers who are mathematicians, economists or financial experts in the stock market whose investment performance cannot even reach the market average?

Open a textbook on financial investment in a bookstore, especially those translated foreign masterpieces, and you will find a large number of mathematical formulas and complex models, which are also the magic weapon used by most funds for investment management.These esoteric and complex models make you admire, but the performance of these funds that continue to lose to the market makes you shake your head.

One of the most famous examples is: Newton, the greatest physicist, lost a lot in stock investment!
The reason for this is that investment is not a pure intellectual game like natural science, but because on the one hand, investment results have a great impact on the future interests of investors, and there is a world of difference between right and wrong investment profits and losses. On the one hand, there are too many factors that affect stock prices and are too uncertain, and almost all of them are not within the grasp of investors. Therefore, investors' decision-making is similar to gambling, which is affected by many psychological factors, and it is not like school exams or scientific research. Only certain conditions are needed to infer the correct result.We often feel that buying a stock is even more difficult than choosing a lover or friend.

The behavioral cognitive bias in the investment process of behavioral finance research has important reference significance for us to maintain a correct investment attitude.The premise for investors to beat the market is to remain rational and reduce behavioral cognitive biases as much as possible.

When communicating with many investors, when everyone recalls the biggest loss in their investment, most of them are because they listened to gossip, or believed too much in the company's business forecast, or were too superstitious about technical analysis indicators. I didn't rationally analyze the company's fundamentals at all, and the result was a mess, and I regretted it.

Buffett has witnessed similar tragedies repeatedly in his 50 years of investment. Therefore, he has repeatedly reminded investors that they must remain rational in order to overcome the often irrational market.

Let us review the development trajectory of China's stock market over the past year or so.Since 2006, China's stock market has reversed the decline of the previous few years. With the support of a large amount of capital inflows, the stock index has been rising steadily. The Shanghai Composite Index rose by more than 2006% in 130, becoming the world's largest stock market.After entering 2007, encouraged by the money-making effect formed since 2006, more and more ordinary people still joined the army of stock speculation after the beginning of the new year. At the beginning of 2007, the stocks of individuals and institutions in the A-share market had reached About 7000 billion yuan, more than three times that of early 2006.Among them, in December 3, the A-share market experienced the phenomenon of capital "sprinting into the market", with a one-way inflow of more than 2006 billion yuan.

After the stock market has continued to rise since 2006, more and more people and funds have been sucked into the ranks of speculators.In less than half a month since the beginning of 2007, the People's Bank of China, the State Administration of Foreign Exchange, and the China Securities Regulatory Commission have successively introduced regulatory measures. The management has begun to worry about the bubbles in the stock market and other asset markets.Relevant state departments have adopted regulatory measures such as imposing stamp duty and raising interest rates to solve the problem of excessive RMB liquidity and avoid the risk of bubbles in assets such as stocks.But in a bull market, people's investment is relatively irrational. Every investor thinks he can win, but in fact many investors end up losing.

In fact, in today's "stock market boom" environment, it is necessary for the majority of investors to have a full understanding of the investment risks involved, so as to avoid irrational investment behavior.As Buffett said: "Investment must be rational, and if you can't understand it, don't do it."

Investment motto:

Investment is not an intellectual game. A person with an IQ of 160 may not beat a person with an IQ of 130. Rationality is the most important factor in investment. Successful investors are often very rational.

(End of this chapter)