Daniel Kahneman, the Nobel Prize winner in economics, has an informative short interview in the Inc.com Idea Lab. He has some quick comments on a number of decision traps or behavioral problems with decision-making that make a strong case for why systematic investing is an effective tool. He discusses a number of decision traps that can be avoided through systematic trading. I provide some of the simple solutions, which are all on the same theme. Use the numbers!
Loss aversion - Your irrational fear of loss and how it messes with your decisions.
Solution: A stop-loss rule can eliminate this problem
Overconfidence - We place more stock in our abilities than the facts would suggest. "Always trust your numbers, never trust your gut".
Solution: The numbers and history do not lie. It may not repeat but the truth is in the numbers. Use data.
Outliers - One event can skew your outlook.
Solution: The most recent numbers are usually embedded in our brains. Outliers are often vivid reminders which can be an issue. Avoid the "law of small numbers".
Prediction - Personal stories have more impact.
Solution: That is the problem: our personal experiences cloud judgment, especially if our experience is limited.
Luck - We confuse luck with skill. "Don't mistake random events for causes".
Solution: Most of what we experience in the markets are random events. Systematic investing tries to look for statistically significant relationships.
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