Many experts believe that to be successful in investing in the stock market, mental discipline is more important than financial knowledge. How you react to panic situations, control your risk, and protect yourself from different biases are all more important in the long run.
So in this article, we are discussing the Top 5 Learnings of the book – Thinking, Fast and Slow. It is written by the famous psychologist and economist Daniel Kahneman.
This article will discuss the top 5 learnings in the book Thinking, Fast and Slow.
Our mind processes thought
As the first learning of this book, we will see how our mind processes thought. The author has said that there are 2 systems in our brain to process any thought.
System 1: We make decisions based on ‘gut feelings’ whereas in System 2: Thinking we lie down on analytical and logical decisions. Whenever we have to make a decision, we usually use System 1 thinking i.e. our gut feelings. That’s because, in System 2 thinking, we need to apply logic and make efforts.
When it comes to investing, System 1 beliefs and assumptions often lead to biased decisions. But we should avoid relying just on our gut feelings and should focus more on logical and analytical thinking while investing.
We will understand the concept of ‘anchoring’ as the second learning of the book. When we make a current decision that is influenced by the information or data already available, it is called Anchoring.
Once upon a time in San Francisco, a charity donation was requested from some visitors. Visitors were asked to donate in 3 different ways.
First case: They requested for donation without demanding any specific amount. In this case, they received an average donation of $64 per visitor.
Second Case: They requested a donation of $5 from their visitors. In this case, they received an average donation of $20 per visitor.
Third case: They requested visitors to donate $400. In this case, they received an average donation of $143 per visitor.
So as we can see, when visitors were asked to donate $5, an average visitor just donated $20. But an average visitor donated $143 when asked to donate $400. So according to the information given to the visitors, there was a significant change in their donation amount.
This is exactly how anchoring affects us. Even while investing, we make our decisions based on the information already available.
Suppose you have bought a stock for Rs 100 and in a few days, its value becomes Rs 10. So you will feel that now this stock has fallen a lot, but maybe that stock is worth 10 rupees according to its business. But you have bought the stock for Rs 100 so it will affect your future decisions. But in such cases, we should take rational decisions by analyzing the current valuations and fundamentals of the stock.
According to the concept, when we get information about something easily, then that thing seems more important or true to us. Because of this, we often make wrong decisions even in the stock market.
Suppose there are 2 stocks – A and B and both stocks are equally good. But if all the news channels are talking about only stock A, then an impression becomes that stock A is better. Because we get information about it easily.
Investors invest their money in the stocks that are trending in the news or the hottest stocks in the industry without doing a thorough analysis. But it is not necessary that the stock which is in news is a good stock.
Often there are companies that do not have much media coverage but after a few years, their stocks become multi-baggers.
Whenever something good or bad happens in our life, we change our investment decisions based on that. However, we do not see any relation of the event to the stock market.
For example, the author shares an actual incident when the US military arrested Iraqi politician Saddam Hussein, So we saw a rise in bond prices in the US.
This event has no direct relation to bond prices but it was good news for US citizens and its effect was visible on the bond market as well. This phenomenon is a good example of the narrative fallacy where investors make a connection between 2 completely independent things.
So the conclusion is that as an investor you should influence yourself only with those events which are actually related to your investment.
When we really like one quality of a person, our overall judgment for it changes. For example, if XYZ Company has a good brand value and reputation in the market. When that company announces a new product to its customers, there is an assumption that that product will also be good. But this is not necessarily the case. This behavioural tendency is called the ‘halo effect‘.
How this halo effect works in investing?
Suppose, when an IPO of a popular brand’s subsidiary comes up, we have a perception that it will also be valuable because of the halo effect and we make our investment decisions on our own. But in reality, we should do complete research by ignoring the halo effect and only then take our investment decision.
These were the top 5 lessons from the book. Please let me know your point of view in the comment section.
Don’t forget to subscribe to the Groww channel for the latest updates about the market.