Motley Fool recently posted a very good interview with Legg Mason’s Michael Mauboussin. Mauboussin is one of my favorite market analysts primarily due to his work on behavioral finance.
I love this basic insight about keeping a trading journal. When I first got into the business I kept a very precise (almost to the minute) journal of my actions. I still keep it in my desk and it’s hilarious to read at this point in my career. I used to day trade dollar stocks regularly keeping very precise notes on what I was doing and why. It’s almost unbelievable that I used to do that, but the point that Mauboussin makes is that you can better learn to avoid your own biases by keeping record of your mistakes. Of course, trading dollar stocks I made a lot of mistakes. But I was on a hyperactive learning process due to my record keeping. Anyhow, I’ll let Mauboussin explain:
Mauboussin: Yeah, this is great. Many years ago when I first met Danny Kahneman, and Kahneman is one of the preeminent psychologists in the world who won a Nobel Prize for economics in 2002, even though he’s never taught an economics class.
When I pose him the question, what is a single thing an investor can do to improve his or her performance, he said almost without hesitation, go down to a local drugstore and buy a very cheap notebook and start keeping track of your decisions. And the specific idea is whenever you’re making a consequential decision, something going in or out of the portfolio, just take a moment to think, write down what you expect to happen, why you expect it to happen and then actually, and this is optional, but probably a great idea, is write down how you feel about the situation, both physically and even emotionally. Just, how do you feel? I feel tired. I feel good, or this stock is really draining me. Whatever you think.
The key to doing this is that it prevents something called hindsight bias, which is no matter what happens in the world. We tend to look back on our decision-making process, and we tilt it in a way that looks more favorable to us, right? So we have a bias to explain what has happened.
When you’ve got a decision-making journal, it gives you accurate and honest feedback of what you were thinking at that time. And so there can be situations, by the way, you buy a stock and it goes up, but it goes up for reasons very different than what you thought was going to happen. And having that feedback in a way to almost check yourself periodically is extremely valuable. So that’s, I think, a very inexpensive; it’s actually not super time consuming, but a very, very valuable way of giving yourself essential feedback because our minds won’t do it normally.
Full interview here.