1. Introduction to Behavioral Finance
BEHAVIOURAL FINANCE – ADANI MDP
Thursday, 4 April
Introduction to Behavioral Finance

2. BEHAVIOURAL FINANCE – ADANI MDP 20.04.2019
“Don’t fool yourself, and remember you are the easiest person to fool.”
Richard Feynman

3. PROBABILITY v/s POSSIBILITY
BEHAVIOURAL FINANCE – ADANI MDP
PROBABILITY v/s POSSIBILITY

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5. Recency Bias while looking at the the Nifty 50
BEHAVIOURAL FINANCE – ADANI MDP
Reversion to the Mean
&
Recency Bias while looking at the the Nifty 50

6. Is it a Stock Market or Is it a Market of Stocks
BEHAVIOURAL FINANCE – ADANI MDP
Is it a Stock Market or
Is it a Market of Stocks

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"All investment is, is laying out some money now to get more money back in the future. Now, there’s two ways of looking at the getting the money back. One is from what the asset itself will produce. That’s investment. One is from what somebody else will pay you for it later on, irrespective of what the asset produces, and I call that speculation. So, if you are looking to the asset itself, you don’t care about the quote because the asset is going to produce the money for you." --Warren Buffett

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We are the market - since we can’t beat ourselves, it follows that we can’t beat the market over the long-term

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Behavioral Finance is the study of the influence of psychology on the behaviour of investors and their effect on the markets

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“Stocks are ownership shares of businesses; they are not pieces of paper that bounce around on which you calculate Sharpe and Sortino ratios. They are ownership shares of businesses that we value, and either buy at a discount or short when they are overpriced.”
Joel Greenblatt

11. Humans are Irrational 90 percent of the time
BEHAVIOURAL FINANCE – ADANI MDP
Humans are Irrational 90 percent of the time
We make Emotional Decisions, not Rational Ones

12. “Investing isn’t about beating others at their game.
BEHAVIOURAL FINANCE – ADANI MDP
“Investing isn’t about beating others at their game.
It’s about controlling yourself at
your own game.“
B E N J A M I N G R A H A M

13. "The investor's chief problem—
BEHAVIOURAL FINANCE – ADANI MDP
"The investor's chief problem—
and even his worst enemy—
is likely to be himself." –
B e n j a m i n G r a h a m

14. We make Emotional Decisions, not Rational ones
BEHAVIOURAL FINANCE – ADANI MDP
We make Emotional Decisions, not Rational ones

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Pendulum Swing

17. ECONOMY AND THE STOCK MARKET
BEHAVIOURAL FINANCE – ADANI MDP

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19. BROWNIAN MOTION
BEHAVIOURAL FINANCE – ADANI MDP

20. An Investing Edge is defined as ‘a technique,
BEHAVIOURAL FINANCE – ADANI MDP
An Investing Edge is defined as ‘a technique,
observation or approach that creates a cash
advantage over other market players. It doesn’t
have to be elaborate; anything that adds a few
points to the winning side of an equation builds
an edge that lasts a lifetime’.

21. Informational Edge Analytical Edge Time Horizon Edge Behavioral Edge
Behavioral Finance – ADANI MDP
Informational Edge 
Analytical Edge 
Time Horizon Edge
Behavioral Edge

22. Things that are known to everyone aren’t worth knowing.
BEHAVIOURAL FINANCE – ADANI MDP
Things that are known to everyone aren’t worth knowing.

23. There is someone on the other side of the Trade. Who are the they?
BEHAVIOURAL FINANCE – ADANI MDP
There is someone on the other side of the Trade. Who are the they?

24. Time isn’t the main thing. It’s the only thing. Miles Davis
BEHAVIOURAL FINANCE – ADANI MDP
Time isn’t the main thing. It’s the only thing. Miles Davis

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28. Life has hidden information, not so in Chess
Life ≠ Chess
Life has hidden information, not so in Chess
There is no element of Luck in Chess, not so in Life.
BEHAVIOURAL FINANCE – ADANI MDP

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Unknowingly, we treat our life decisions as if they were Chess decisions

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Outcome Quality ≠ Decision Quality
Decisions & Outcomes are not PERFECTLY Correlated

31. Net, Net – Chess cannot be a model for decision-making in our lives
BEHAVIOURAL FINANCE – ADANI MDP
Net, Net – Chess cannot be a model for decision-making in our lives

32. BEHAVIOURAL FINANCE – ADANI MDP 20.04.2019
Socionomics is defined as the study of social mood and its influence over social attitudes and actions.

33. Socionomics Socionomics Socionomics
Behavioral Finance - Adani MDP
BEHAVIOURAL FINANCE – ADANI MDP
Socionomics Socionomics Socionomics
The chicken of economic weakness produced the Brexit egg from which further economic woe is hatching.

34. Herd Mentality – Following the Crowd

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 “Rationality resides in what you do, not in what you think or in what you “believe” (skin in the game).... Rationality is about survival.” — Nassim Taleb

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 Rational Behaviour is one that is based on (a) our ability to think in a logical way and (b) our capacity to change according to our thoughts

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Rational Investing in Irrational Markets is what Behavioral Finance is All about.

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39. Being Irrational is not always a bad thing
BEHAVIOURAL FINANCE – ADANI MDP
Being Irrational is not always a bad thing

40. Type 1 Error - False Positive Type 2 Error - False Negative
BEHAVIOURAL FINANCE – ADANI MDP
Type 1 Error - False Positive
Type 2 Error - False Negative

41. Our Beliefs form the basis of our decision-making
BEHAVIOURAL FINANCE – ADANI MDP
Our Beliefs form the basis of our decision-making

42. How do we form our beliefs How do we change our beliefs
BEHAVIOURAL FINANCE – ADANI MDP
Beliefs and Filters
How do we form our beliefs
How do we change our beliefs

43. Experience is a hard teacher because she gives the test first,
BEHAVIOURAL FINANCE – ADANI MDP
Experience is a hard teacher
because she gives the test first,
the lesson afterwards.

44. We love predictions and follow those who we think can predict
BEHAVIOURAL FINANCE – ADANI MDP
Human Minds are emotional - Once the emotions creep in, irrationality follows.
We love predictions and follow those who we think can predict

45. Heuristics v/s Probabilities Humans make decisions on the basis of
BEHAVIOURAL FINANCE – ADANI MDP
Heuristics v/s Probabilities
Humans make decisions on the basis of
instinct using Heuristics / Shortcuts.

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A cognitive bias is defined as a mistake in reasoning, evaluating or remembering often occurring as a result of a deviation from our judgment and leading to irrational behaviour on our part.

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Cognitive Dissonance is the mental condition in which people rationalize why their actions are inconsistent with their thoughts and beliefs.

48. A belief must be held with deep conviction.
BEHAVIOURAL FINANCE – ADANI MDP
A belief must be held with deep conviction.
The person holding the belief must have committed himself to it.
The belief must be sufficiently specific and sufficiently concerned.
Such undeniable dis-confirmatory evidence must occur.
The individual believer must have social support.

49. Justify your beliefs and your behaviours.
BEHAVIOURAL FINANCE – ADANI MDP
Change your behaviour.
Change your beliefs.  
Justify your beliefs and your behaviours.

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Confirmation Bias is the human tendency to see all evidence as supporting your beliefs, even if the evidence is nothing more than coincidence. Again we believe it happens only to others and not to ourselves.

51. Effects of Confirmation Bias Encourages homogeneity of thought
BEHAVIOURAL FINANCE – ADANI MDP
Effects of Confirmation Bias
Encourages homogeneity of thought
Leads to poor decision making

52. Remedies to Confirmation Bias Open mindedness Viewpoint diversity
BEHAVIOURAL FINANCE – ADANI MDP
Remedies to Confirmation Bias
Open mindedness
Viewpoint diversity

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56. where the system is built to prey on one of our deepest biases.
BEHAVIOURAL FINANCE – ADANI MDP
Unseen algorithms push us more of what we like, so that we’ll spend more time on the host sites. It’s a dangerous feedback loop,
where the system is built to prey on one of our deepest biases.

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Filter Bubbles
Filter Bubbles are defined as: a phenomenon in which a person is exposed to ideas , people, facts or news that adhere to or are consistent with a particular political or social ideology.

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Filter bubbles may not seem that real to us, because we see these views from a distance, but that is not real engagement, and does more harm than good.

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Motivated Reasoning
Francis Bacon summed it up in 1629, as succinctly as any modern behavioural scientist: The human understanding when it has once adopted an opinion draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found o the other side, yet these it either neglects or despises.

62. Behavioral Finance - Adani MDP 20.04.2019
BEHAVIOURAL FINANCE – ADANI MDP
Emotion: Greed v/s Fear

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65. You can take the monkey out of the status-seeking game,
BEHAVIOURAL FINANCE – ADANI MDP
You can take the monkey out of the status-seeking game,
but you can’t take status-seeking out of the monkey

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The Stock Market has become a spectator sport. As a result, the Signal to Noise ratio is very low

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1 % Rule – Everyone else is a lurker, as in any spectator sport – no Skin in the Game

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Keynes Beauty Contest as a means to explain price fluctuations in the stock market.

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Each participant had to pick, not those faces which he (or she) finds prettiest, but those which he thinks likeliest to catch the fancy of the other participants. 
The prize was awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole.

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‘We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.’ (Keynes, General Theory of Employment Interest and Money, 1936).”

71. Mindfulness v/s Mindlessness
BEHAVIOURAL FINANCE – ADANI MDP
Mindfulness v/s Mindlessness

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Mindlessness is an act in which we fail to possess control over our thoughts and the individual intellect that we possess.

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When there is nothing clever to do the mistake lies in trying to be clever - Howard Marks

75. We can say the same about markets - whenever in doubt, stay out.
BEHAVIOURAL FINANCE – ADANI MDP
 It’s better to be on the ground wishing you were in the air, than in the air wishing you were on the ground”.
We can say the same about markets - whenever in doubt, stay out.

76. We are behaving like Pavlovs Dogs

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 Man in the Mirror – How to Generate Behavioural Alpha

78. The Experts are not immune from Behavioral Biases
BEHAVIOURAL FINANCE – ADANI MDP
The Experts are not immune from Behavioral Biases
Keep the experts on tap, not on top

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Confidence is knowing that you can make it through the day without screwing up. Overconfidence is thinking that you can do it again tomorrow.