The Investment Scientist

Why We Like To Buy Stocks When They Run Up A Lot?

Posted on: March 26, 2020

 

drawing-chart-going-up.jpgAfter three days of the stock market rallying, I have noticed a change of tune among my clients who have been calling me. Three days ago, a few of them were asking if they should get out of the market altogether and wait until things turned the corner. Three days and 20% higher in the Dow, they want to increase their investment in stocks. But why? Why are stocks so bad when they are 20% cheaper and so good now that they are 20% more expensive!?

There is a little mental quirk that has been playing games with us. This quirk was discovered by Nobel Prize winner Daniel Kahneman, together with his trusted collaborator Amos Tversky who died too young to share the Nobel Prize. This quirk is called “availability bias.” That is when we assess the probability of a future event, we try to recall that event from our memory. If the event can be easily recalled, we subjectively judge it to be more likely.At the start of this week, following a “bad” week last week, and another day of falling markets on Monday, when investors were assessing the future of the market, guess what memory was freshest for them? Yes, it was that of the market falling, so the availability bias caused them to assign a much higher probability of the market going further down. No wonder some of they wanted to get out. (By the way, I think last week was a good week for me since I was able to rebalance into the 30% market discount for most of my clients.)

Now, after three days of rally, guess what memory is freshest? Yes, it was that of the market going up. So availability bias has caused us to add more weight to the probability of the market going up and we become more willing to invest in stocks.

Believe it or not, this little mental quirk has caused many investors to lose a lot of money. Just imagine liquidating the portfolio three days ago and buying back today. It’s an instant 20% loss right there! Don’t underestimate the power of this little quirk!

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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