Opinion: Why Changing Investment Strategies to Gain an Edge in the Market Leaves You Only Behind

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“Too much information” generally refers to the inappropriate sharing of excessive personal details, but TMI can also sabotage your wallet. TMI is a big deal on Wall Street, where it poses an entirely different kind of challenge: Analysts are paralyzed by a never-ending search for more and more information, hoping that one more indicator or econometric analysis will provide that crucial edge.

Researchers have found that not only does this search quickly reach the point of diminishing returns, it actually backfires. The perfect is the enemy of the good, in other words. You are likely to do better over time by choosing a decent strategy and following it with discipline than by constantly questioning your chosen strategy in hopes of perfecting it. One of the best illustrations of this phenomenon is a study conducted nearly 50 years ago by Paul Slovic, a professor of psychology at the University of Oregon. (I was reminded of this study in a recent post in Macro Ops, a market research firm.) Slovic set out to measure whether our predictions get more accurate as we analyze more and more pieces of information. He discovered that this was not the case. Slovic reached this conclusion after analyzing a group of professional horse handicappers selected for their experience. They were presented with a list of 88 variables from which they could choose a handful that would be the basis for their predictions of which horses would win in various 10-horse races. For a set of races, they were allowed to choose only five of those 88 variables. They were allowed to progressively focus on more variables in the second, third, and fourth sets: 10, 20, and 40, respectively. Slovic found that the average success rate of these handicappers remained the same in all four sets: 17%. For one thing, their success rate was impressive, as if they weren’t better than a coin flip, I would have expected them to be correct only 10% of the time. On the other hand, increasing the number of variables had no effect on their predictive success. That’s pretty sobering, but it’s what Slovic measured next that’s really depressing. In each of the four sets of races, he asked the handicappers how confident they were in the accuracy of their predictions. As you can see in the chart below, their confidence level grew noticeably as they were able to focus on more and more variables. Therefore, the net effect of the additional analysis that the handicappers were able to perform was to increase their self-confidence.

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To be sure, Slovic is quick to admit that horse racing is not the same as investing. But they are not as different as many investors would like to admit. Horse races have newsletters and fact sheets, as do investments. Horse racing newsletters are filled with charts and graphs that cut and cut the past performance of each horse. “It doesn’t take much imagination to see the similarities between these types of charts and the data sources used in some forms of financial analysis,” Slovic writes. Confirmation bias You may wonder why professional handicappers did not improve their predictive skills when they focused on more variables. One response, as described in the Macro Ops article, is what is known as confirmation bias, defined by Wikipedia as “the tendency to seek, interpret, favor, and remember information in a way that confirms or supports beliefs or values. previous “. Here’s how it might work: By the time they had absorbed their five favorite variables, the handicappers had already reached at least one tentative conclusion about the horses they wanted to bet on. When additional variables above and beyond those five pointed to the same conclusion, handicappers felt more confident that their original judgment was correct. When the additional variables pointed to a different prediction, they gave those variables less weight or ignored them altogether. Confirmation bias is also widespread in the stock market, of course. Investing causes anxiety, so it is natural that we gravitate towards arguments and studies that confirm our current perspective. This process is usually unconscious, but almost all of us suffer from it. Bulls look for justifications to be bullish even when bears look for arguments why they should be bearish. Having spent over 40 years monitoring the daily arguments of hundreds of investment newsletters, I can assure you that there is never a lack of arguments on both sides of any topic imaginable. It is incredibly difficult to keep an open mind in the face of these myriad conflicting arguments. That is why the endless search for one more historical indicator or analysis is often so futile. The assumption of that search is that there is a perfect approach or strategy, and our job is to find it. But that assumption is wrong. And the search that that assumption leads to causes us to lose the discipline that would make a good (but not perfect) long-term strategy profitable. Patience and discipline The key is to choose an investment strategy that has a good long-term track record and then stick with it through thick and thin. You won’t always be at the top of the performance draws, so you need to develop the discipline to keep going through tough times. Otherwise, you will find yourself constantly questioning your approach, which is the complete opposite of having patience and discipline. Think of it this way: even if your never-ending search really uncovered the “perfect” strategy, it wouldn’t help your long-term performance if you didn’t follow it with patience and discipline. In fact, you would probably end up earning less from it than from a strategy that might be flawed on paper, but is diligently pursuing. Patience and discipline can turn a merely decent strategy into a winner, while a lack of those two qualities can turn a “perfect” strategy into a loser. Mark Hulbert is a regular contributor to MarketWatch. Your Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com More: Why Generation ‘I’, YOLO investors who have never seen a bear market, should concern us all. Also Read: Why the ‘Fed Put Option’ Makes Low Volatility Stocks an Attractive Replacement for Bonds