The rally in the stock market has produced many new stock pickers. However, many of these investors suffer from a bias: they judge the success or failure of a stock based on its price, which is an incorrect measure of its performance. Investors should avoid this mental trap to protect their wealth. Many investors judge the quality of their investment decisions based solely on the short-term movements of stock prices. They see rising prices as a validation of their choices and seek confirmation from others.

_{THE CRUX OF THE ISSUE}

The adage ‘a rising tide lifts all boats’ holds true in the stock market, where sustained upward trends, buoyed by liquidity and sentiment, can transform every stock into a potential multi-bagger. Consequently, identifying the next multi-bagger appears easy and gains widespread popularity. This phenomenon raises the likelihood of any investor, regardless of their knowledge, skills, temperament, or experience, assuming the role of a successful stock picker.

However, this winning streak often breeds excessive confidence, which may ultimately prove to be a mere illusion or, as Nassim Nicholas Taleb aptly described, falling victim to the hidden role of chance in life and the markets. There are several reasons as to why judging the success or failure based on its stock price is an incorrect measure of a stock‘s performance. First, the stock market is an extremely volatile place, and prices are likely to fluctuate wildly.

This means that even a good investment’s price can go down in the short term. Second, stock prices are not always a reflection of a company’s underlying fundamentals. For example, a stock price can go up even if a company is losing money. Finally, stock prices can be manipulated by market participants, which can make them even less reliable as a measure of
performance.

 

 

CHECK YOUR BIASES

 

CONFORMATION BIAS: EVERYTHING IS PRICE

Many people suffer from confirmation bias. One common mistake that investors make is to think that they are right because their tock has gone up in price. For example, let’s say that you buy a stock for 100. The stock then goes up to 200. You might think that you are a genius investor because you made a 100% return on your investment. However, the truth is that you could have just  otten lucky.

The stock could have gone up for any number of reasons, and it could just as easily go down in the future. The feeling  hat you can turn anything into gold has a cascading impact on the amount of money and people involved. The consistent  utperformance that is based on false assumptions gets bigger and bigger as people move forward. Ignoring mistakes, self-doubt,  nd overconfidence in luck-based outcomes can be disastrous.

AVAILABILITY BIAS

Another common bias is availability bias, which refers to the tendency of relying on readily available information instead of seeking out more comprehensive data. For instance, an investor may base their investment decisions on recent news articles or Social media posts, rather than conducting a thorough analysis of the company’s financial statements and market trends.
 

OTHER BIASES

Like availability bias, there are several other biases, including recency bias, social proof, anchoring, and many more, that can work together. For instance, recency bias can cloud our judgment by causing us to focus only on recent information and results, while disregarding the broader historical context of business cycles, stock markets, and even our own ability to make rational decisions and act on strategies. In the realm of social media platforms, another common bias that can come into play is social proof.

With millions of active users on these platforms, there is a significant reach across the world, creating a powerful social proof. This phenomenon can lead many individuals to make irrational and illogical decisions, even in areas such as investing and the stock  market.
 

THE DANGERS OF JUDGING YOUR INVESTMENT DECISIONS BASED ON PAST PERFORMANCE

There are several dangers associated with basing investment decisions solely on past performance. Firstly, it can lead to overconfidence as witnessing rising stock prices may inflate one's belief in their investing abilities, prompting them to take riskier bets that can ultimately result in losses. Secondly, it can cause investors to overlook red flags as they become solely focused on positive outcomes, potentially missing warning signs of an impending stock decline.

Consequently, they may hold onto a stock for too long, resulting in financial losses. Lastly, relying solely on past performance can lead to making emotional decisions. When confronted with falling stock prices, panic can set in, leading to hasty selling that often results in selling at a loss.
 

HOW TO AVOID MAKING THIS MISTAKE?

 

DON’T JUDGE YOUR INVESTMENT DECISIONS BASED ON PAST PERFORMANCE
 

Rather than judging investment decisions solely based on past performance, it is important to shift the focus towards the future otential of the company.

 

As legendary investor Peter Lynch once wisely stated, “The stock market is filled with individuals who know the price of everything but the value of nothing.” By prioritizing the value of a company and its potential for growth, nvestors can make informed decisions that significantly enhance their chances of achieving success.

 

IT IS IMPORTANT FOR INVESTORS TO DEVELOP AN OWNER’S MINDSET

Cultivating an owner’s mindset, which entails thinking like a business owner rather than a stock trader, is the most important aspect to follow. As Warren Buffett aptly said, “When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.” By adopting this perspective and placing emphasis on the long-term value of a company, investors can significantly enhance their chances of achieving success.

DO YOUR RESEARCH AND UNDERSTAND THE RISKS INVOLVED

Since no investment is guaranteed, it is vital to conduct thorough research and comprehend the risks associated with investments. Being aware of the potential for losses is essential. This entails going beyond stock prices and considering a variety of factors, including the company’s financial statements, market trends, and industry outlook. As Warren Buffett wisely said, “Risk comes from not knowing what you’re doing.”

By dedicating time to research and gaining a comprehensive understanding of the risks involved, investors can make informed decisions that minimize their exposure to risk.
 

BE PATIENT AND DON’T EXPECT TO GET RICH QUICK

Avoid expecting quick riches from the stock market. Recognize that the stock market is a long-term game, where success often stems from holding onto good companies for an extended period of time. One of the biggest isconceptions about the stock market is that it is a get-rich-quick scheme.

As legendary investor Benjamin Graham once pointed out, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

By focusing on finding good companies with strong fundamentals and holding them for the long term, investors can increase their chances of success and achieving their financial goals.
 

KEEP ON LEARNING AND QUESTIONING

Also, continuous learning and questioning are essential.

As legendary investor Charlie Munger wisely observed, “I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are  earning machines.They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.”

By staying curious and constantly learning, investors can improve their skills and knowledge, and increase their chances of success in the long run. While luck may play a role in investment outcomes, relying on skills and knowledge is a far better source of success in the long run. Luck can sustain only for a period. In the end, the reliance on skill and knowledge is going to pay as Buffett described, “Only when the tide goes out do you discover who's been swimming naked.”

 

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