Book Reviews, Trading, Value Investing

Book Review of The Emotionally Intelligent Investor by Ravee Mehta

The full title of this book is The Emotionally Intelligent Investor: How Self-Awareness, Empathy and Intuition Drive Performance by Ravee Mehta.

According to the bio in the book, Ravee previously held positions at Soros Fund Management and Donaldson, Lufkin & Jenrette. He was a managing director for 8 years at Karsch Capital Management, before becoming a self-employed investor.

This is a nice short book on investing psychology. One interesting bit from the book is about how Paul Tudor Jones visualizes different ways his trade could fail, so that he can quick sense danger and react immediately. Another good bit is on thinking about the different groups of players on an instrument, and think about what they would be thinking and feeling.

Do Not Multitask

  • David Brooks: A person who is interrupted while performing a task takes 50% more time to complete it and makes 50% more errors. The brain doesn’t multitask well. It needs to get into a coherent flow, with one [neural] network of firings leading coherently to the next.
  • Not multitasking makes you feel less stressed and more focused, and more in control. Feeling like you are in control makes you less susceptible to fear and errors that result from too much noise / information.

Self-Awareness is Key

  • Investing success does NOT come from ignoring or suppressing emotion. Assuming that you have relevant expertise, disregarding intuition and emphatic feelings because they cannot be explained, is a mistake!
  • Self-awareness is the first and most important step in improving as an investor. An investment approach needs to fit with your unique set of motivations, personality traits, weaknesses and strengths.
  • Humans have certain common investing vulnerabilities, but everybody is unique in their susceptibility to them. Consider your weaknesses to be the investing biases and traps to which you are most prone.
  • Because we are constantly changing, introspection should be incorporated into the daily and weekly routines of any investor. Try writing in a trading journal every day.

Have an Awareness of Other Participants

  • Trading success involves recognizing and taking advantage of the mistakes of others. This requires empathy.
  • Technical analysis is a tool for empathizing with the current shareholders of an investment. Investors that completely ignore stock charts are potentially missing out. However, avoid getting caught in the weeds of chart reading without thinking about what the chart is telling you regarding how other shareholders may be feeling.

7 Questions to Ask Before Making an Investment to Gain an Edge Through Empathy

  1. What does the current shareholder base look like? Is it mostly comprised of value investors who usually bet against the current momentum and take a longer term perspective, or growth and shorter term investors who typically sell after poor results? Is there a high short interest? Does management own a large percentage?
  2. What are the longer term shareholders thinking and feeling?
  3. What are the shareholders who recently bought the stock thinking and feeling?
  4. What is the potential buyer of the stock thinking and feeling?
  5. What is the potential short seller of the stock thinking and feeling?
  6. If the stock has a high short interest, what are those who are already short the stock thinking and feeling?
  7. What is management thinking and feeling?

Technical Analysis Principles

  1. Stocks should be bought when they break out of strong resistance levels, especially when the breakout is accompanied by high volume and / or overly negative sentiment. When a stock breaks out above resistance, the old resistance level becomes a support level.
  2. Stocks should be sold when they break through strong support levels, especially when the breakdown is accompanied by high volume and / or overly positive sentiment. When a stock breaks through a support level, the former support level becomes a resistance level.
  3. A stock making higher highs and higher lows is more likely to go up than a stock making lower highs and lower lows.
  4. Bull markets tend to top out when market breadth declines. Market breadth can be defined as the number of stocks in the market making new highs. Similarly bear markets tend to bottom out when there is a declining number of stocks making new lows.
  5. Bull markets tend to top out when the leading group of stocks start underperforming.
  6. The end of bull markets and the ned of bear moves often have one last big move up and down respectively.
  7. Stock prices tend to go down much faster than they go up.
  8. Short term overbought / oversold indicators help with timing. One should avoid initiating a full long position in a stock that has recently had a large up move, which would make it technically overbought. Similarly, one should avoid initiating a full short position in a stock that has recently had a large down move, which would make it technically oversold.

How to Use Intuition Safely

  1. Ask yourself whether your intuition concerns something in which you have ample experience. If not, you should be very hesitant to rely on your emotions.
  2. There is a chance that the feeling is a result of an emotional bias that is harmful to investing. The best defense against these biases is self-awareness. Remind yourself of your emotional biases.
  3. Think of a previous situation that is similar to the fact set at hand. If we cannot remember any other prior investment that seems similar, we should be hesitant to rely on our gut feelings.
  4. Know your risk / reward and the probabilities of positive and negative events occurring.
  5. Bounce ideas off someone else.
  6. Set up trip wires and remain open to changing your mind. Trip wires are events that should not occur if your thesis and intuition is right.

Visualize Failure to Sense Danger and React Faster

  • A pre-mortem exercise involves mental simulation of failure and then thinking of all the possible reasons for its occurrence. Starting with thinking about failure and then working backwards to mentally simulate what could have gone wrong actually creates ‘virtual experiences’ that can lead to gut instincts that help to sense danger.
  • Investors that have a better idea of what can go wrong with their investments are more in control. This empowers them to sell when others are still evaluating the unexpected development or are inappropriately adding even more risk.
  • Paul Tudor Jones spends an hour every night conducting mental simulation exercises. He thinks about various scenarios such as the price of oil rising significantly or the Euro declining significantly. Jones tries to understand how certain events can impact his portfolio. He uses these visualization exercises to discover flaws in his portfolio and makes adjustments as needed. These mental simulations also prepare him to react immediately to macro-economic news and changes in the market.

How to Build Intuition

  • Intuition is based on pattern recognition. Good decision-making should start with intuition and should then be safeguarded with logic. Every potential investment should remind you of something that was successful where luck was not a major factor.
  • Intuition is best built through objectively reviewing prior decisions. It is important to make this a continuous process, since investing intuitions can become obsolete. Gut instincts can also be developed through mental simulation exercises. Instead of simply listing risk factors, try to visualize failure and then work backward to understand patterns that help with sensing danger.

Match a Thesis with the Approach

  • It is important to make sure an investment’s thesis matches the approach. For example, don’t use valuation as the main justification for an investment in a stock that has been performing well for some time. Likewise, don’t get shaken out of a highly contrarian bet just because short term business conditions are slightly worse than expected.

Success Comes from Being Aggressive with High Conviction Trades

  • Conviction is arrived at by first having a strong intuitive feeling regarding an investment. Certain patterns emerge that make a situation predictable. Given a familiar fact set, the master investor can cut through uncertainty. Therefore, he can take advantage of what is less apparent to most others. The master investor then uses his reasoning to safeguard his intuition.
  • He also develops an empathetic edge with other market participants. He knows that as uncertainty declines, he will be paid for taking on risk that others were unwilling to assume. He knows what will make others buy after him.
  • Conviction also involves foresight of what can go wrong. Consequently, the master investor senses, before others, dangerous patterns emerging.
  • In the end, with a high conviction investment, the master investor makes more money than others when he is right and loses less money than most others when he is wrong.





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