Price on Value
August, 2000

More Investor Maladies:
The King Kong Syndrome and Tradophilia

John Price,  Ph.D.

Do you hate to admit that you are wrong? Do you hang on to stock losers while muttering through clenched teeth, "Don't worry, Dear. It will come back." If so, as I said in my last article, you may be suffering from get-evenitis.

Get-evenitis is just one of a number of investor diseases that have their basis in the King Kong syndrome. This is the syndrome of selectively choosing data to support your opinion. "Don't bother me with facts. I am the mighty King Kong" is the mantra of those afflicted with this malady.

This disease is not something new. For example, Benjamin Franklin wrote, "So convenient a thing it is to be a reasonable creature, since it enables one to find or make a reason for everything one has a mind to do." Or going back even further, in the Bible we read, "When your herds and flocks grow large and your silver and gold increase and all you have is multiplied, then your heart will become proud ... and you may say to yourself, 'My power and the strength of my hands have produced this wealth for me.'" (Deuteronomy, 8:13-14, 17)

Even though the disease is not new, this recent climate of stock market euphoria has led to a particularly virulent strain. With this record bull market it is too easy to attribute success to our own abilities and not to good fortune.

How about the following remark as a King Kong statement in the area of interest rates. In July 1993, Robert Citron, the treasurer of Orange County, California, predicted that interest rates would not rise. When asked how he knew this, he replied, "I am one of the largest investors in America. I know these things." Within a little over a year it was public knowledge that Citron was deluding himself. His prediction of how interest rates would move was wrong, his error causing the Orange County Investment Pool to lose $2 billion forcing the County into bankruptcy.

Even more, we often have the dangerous habit of searching for evidence to support our beliefs rather then openly considering information that might contradict our opinions. According to B. Fishhoff in a 1982 collection of papers called Judgment Under Uncertainty, we even 'misremember' our own predictions in order give the appearance of having made accurate forecasts.

Trading is another area where the King Kong syndrome is very apparent. What is it about trading that is so attractive? Here I do not mean individuals who make all or part of their living by trading. Rather I mean trading that is larger and more frequent than is justified by the information available and the level of analysis. I call this investor malady tradophilia, an irrational love of trading.

When I think of this excessive trading I am reminded of what Van Tharp refers to as the 'lotto bias.' State run lotteries hit on a goldmine when they allowed the participants to choose their own numbers rather than be simply given a ticket. With this small change in the way people can choose their tickets they now feel in control. They can choose their own numbers and so have the illusion of increasing their chances of winning. This illusion of control, as it is referred to by the psychologists, leads to overconfidence, even hubris, more signs of the King Kong syndrome.

Am I being unfair on trading? Not according to a study by Brad Barber and Terrance Odean of the University of California at Davis. (The study is forthcoming in the Journal of Finance.) The authors examined the trading histories of 60,000 households over a six-year period ending in January 1997. They found that after accounting for trading costs, the households underperformed a general market-weighted index by 1.1 percent annually.

There is more. The 20 percent of households that traded most often had an outcome that was five times worse than the general group. Their returns lagged the market index by 5.5 percent annually. This figure increased to 10.3 percent annually when the analysis included the fact that the high-turnover households tilted their portfolios towards small stocks with high market risk. Barber and Odean end their paper by saying, "Those who trade the most are hurt the most."

It seems that the households, particularly those with the highest turnovers, overestimated the value of the information that they had. This is the same mistaken belief that makes the choose-your-own number lotteries so successful for those that run them.

We all have these investment diseases to varying degrees and perhaps it is impossible to be completely free of them. One of the best ways I know of strengthening our immune systems so that the diseases are kept at a tolerable level is to keep a stock book. Before you buy a stock in a company write down some of its key features with particular emphasis on those things that you consider most important for your decision making process. It could be products and competitors, it could be price and volume movements, or it could be fundamental ratios. Or it could be that you run through the calculations with the investment software Valuesoft. (Of course, I would hope that you would do that anyway.) Whatever are the touchstones for your buying and selling, take the time you need to implement them and jot them down.

Peter Lynch was a great advocate of recording his thoughts on different companies. When he was the manager of the Fidelity Magellan Fund, Lynch kept a series of notebooks in which he wrote down information on companies that he analyzed or visited. He also required that his advisors be able to make brief presentations on any companies that they thought should be considered for the fund. Perhaps you could try this with your spouse or a friend.

Whatever approach you take, my experience is that like many diseases, the investor maladies described in this month's and last month's articles can exist on two levels. Firstly, you can have acute attacks in which case your investment life can come to a sudden and painful end. Secondly, they can lie dangerously dormant for years. Then all of a sudden one or more of them can flare up with unpleasant consequences. Even if they don't flare up, they can exist at a nagging, sub-clinical level causing your investing and trading to be stressful and below par. But forewarned is forearmed.

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To get more details on using Valuesoft as a protection against the King Kong syndrome, tradophilia and other investor maladies click here. Next month marks the second anniversary that I have been writing the Price on Value articles. To commemorate this I would like to go back to one of the ideas that started this journey and look at some perceptive thoughts from Sherlock Holmes on investing.