How to Be a Gun Small-Cap Investor

What is the meaning of life?

Well if you ask the crew at Monty Python, it’s ‘nothing very special’. Or with a little more detail:

Try and be nice to people, avoid eating fat, read a good book every now and then, get some walking in, and try and live together in peace and harmony with people of all creeds and nations.

Not too much to ask really, is it?

I’d go so far to say that it’s also about being the best person you can be. I mean, no one actively tries to be a worse version of themselves day-to-day, do they?

Furthermore, in striving to become a better ‘you’, I’m of the view it helps you in all aspects of your life.

Trying to be a better partner to your significant other. Trying to be a better parent. Trying to be a better friend, a better colleague, a better teammate. And of course, a better investor.

That’s why I will often go on about education being one of the best investments you’ll ever make. That doesn’t mean trotting off to spend thousands on a university course. In fact, in today’s information age you don’t even need to pay in money for education.

I’m also not about to say you can spend cryptocurrency instead. Bet you thought I was though.

No, when it comes to education, today you really only need to pay in one currency…time.

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Time paid is time well spent

When you spend time on learning, it’s always time well spent. And when it comes to investing, one of the most important things to learn is psychology.

Being a gun small-cap investor means knowing how to control emotion. How to understand actions of the market, but also yourself.

You need to learn how to understand your own ‘EQ’ (emotional intelligence). You need to learn where you own flaws are, how to spot them when they present, and how to combat them.

But how do you know what flaws you have if you don’t know what flaws exist?

How do you know you’ve got tachypsychia, if you don’t know what tachypsychia is? How can you identify the law of triviality if those words stump you?

Well thankfully I recently came across a wonderful infographic that steps you through not 10, not 20…but 50 different kinds of cognitive biases. (You can find the link to the infographic at the end of today’s essay).

Even better, these 50 biases are grouped into: memory, social, learning, belief, money, and politics. Often a bias will cover multiple groups.

For example one cognitive bias which I’ve written about before is called anchoring. This is where, ‘we rely heavily on the first piece of information introduced when making decisions.’

An example of this played out incredibly in April 2017. Around this time we introduced the Ethereum cryptocurrency to readers of my Revolutionary Tech Investor publication. Our initial entry price was around US$55 (about AU$83 at the time).

Within a month it had risen to over US$220 — a 300% return in less than a month. Around this time I was speaking to some friends who had decided to enter Ethereum at the time. One had started averaging in at about US$200.

However, by the end of May ETH was back down around US$130. A brisk clip of 40% off its peak. I remember the conversations about ETH and how they were convinced they’d missed the run and missed out on those few hundred of percent gains.

That’s because they were anchored to their entry price. They wanted out and were struggling with this whole new ‘crypto thing’. Had they succumbed to their anchoring cognitive bias they’d have likely tapped out.

To be honest, I’m not sure if they did or not. But I bet if they didn’t when ETH crossed the US$1,000 mark they’ve have forgotten all about it.

Of course anchoring can be dangerous. But so can optimism bias.

And when it comes to being self-aware, I’ll step up here and say that sometimes I suffer from optimism bias.

This is where, ‘we sometimes are over-optimistic about good outcomes.’ This is perhaps my biggest cognitive bias. That’s because I’m what you might call a ‘perma-bull’. That means I’m almost always optimistic even when things aren’t so great.

And that is hard to manage. And in 2017 it was really hard to manage.

Using the Ethereum example, by early 2018 ETH was pushing up to values around US$1,400. That’s over a 2,400% rise from around the US$55 mark from April 2017.

But this rise had vindicated our view on the potential of crypto on the world. Albeit it had come hard and fast and we were now getting crypto tips from near complete strangers.

Making emotionless, smart investing decisions

In fact I was at a wedding at the end of 2017 and someone got wind I was involved in crypto. By the end of the night I’d become a quasi-celebrity amongst the (mainly increasingly drunk blokes) in the room. I was ‘the crypto guy’.

But optimism bias was there and I didn’t identify it fast enough. And by the end of 2018 ETH was bottoming out around US$90. A fall from grace indeed. But the case for optimism was always there and hard to shake.

That doesn’t mean I’m wrong on crypto. But it doesn’t mean I’m always right either.

By that, I mean there are times as an investor when you should look at the markets, assess your biases, and make emotionless, smart decisions. It’s where things like buy the fear sell the greed come from. Like taking profits when they scream out at you or knowing when to cut losses before they get worse.

This is the challenge we face in the markets. Knowing about bias like the two mentioned. Or knowing about others like the Ben Franklin Effect, Clustering Illusion, Framing Effect, Dunning–Kruger Effect are important.

Take a look at the biases. Ask yourself, ‘which ones apply to me?’ Be honest with yourself. And try to manage them with your investing. You’ll never eliminate them all; you’re not a robot after all. But you can learn to manage them and deal with them when they pop up.

Do that and you’ll be a better you.

Oh and here’s the link to the 50 cognitive biases infographic.

Regards,

Sam Volkering,
Editor, Money Morning

PS: Our publication Money Morning is a fantastic place to start on your investment journey. We talk about the big trends driving the most innovative stocks on the ASX, in particular small-cap stocks. Learn all about it here.

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