I've been a history junky for decades…
Reading about ancient battles, famed generals, and the historical events that shaped the world has fascinated me since I was a young boy.
And there's one story, written by the late Peter L. Bernstein, in particular that I want to share with you today.
In his masterful study of risk, "Against the Gods," Bernstein – a financial historian and economist himself – tells the story of a celebrated professor of probability and statistics in Moscow during World War II.
During that time, aerial bombardments of the city were unyielding. Even so, this Soviet scholar avoided air raid shelters. After all, Moscow had 7 million people. "Why should I expect them to hit me?" he would say glibly.
However, one night in late winter, the professor suddenly appeared in one of the shelters.
Several of his comrades happened to be there as well and were shocked to run into this "Doubting Thomas."
They all wanted to know: What caused his shift in attitude?
"There are 7 million people in Moscow and one elephant," he explained. "Last night they got the elephant."
Now, I have to admit that this book is easily one of my favorite reads. The writing and storytelling that Bernstein employs is just masterful.
But I love this interaction in particular for a reason…
It encapsulates the biases human beings have in regard to recent events.
Now, we've talked in length about biases – which simply mean the way we are hardwired to think about and approach investing.
Unfortunately for us, most of those biases are what make us lousy investors.
But today, we're going to dig a little deeper and talk about the most dangerous bias of all – "the single elephant."
Here's what I mean…
Emotions Strike Again
Fact is, as human beings, we may be able to calculate the chance of something happening… We may even understand what those probabilities mean.
But those numbers won't make any difference to us if we fall prey to our wealth-crushing biases.
Take the professor in the anecdote above.
He understood how remote his chance was of being killed.
However, a recent random (and highly memorable) event – the death of the local circus elephant – made him change his decision-making process, and he ultimately succumbed to his emotions.
As investors, we make those same mistakes when it comes to our trading.
And it can have a cataclysmic impact on our wealth.
Traders without a simple-but-powerful system to guide them are the first to abandon their investing strategy when random (and highly memorable) events occur.
I call it the "recency" or "single elephant" bias.
Let's take a closer look…
Three Ways to Combat the "Elephant" in the Room
If you're like most traders and investors, something like this has happened to you.
You have a strategy in place that tells you what stock to buy. The strategy tells you how to get out if you're wrong or hang on when you're right. Through testing or real-time use, you know that the strategy works.
And then it happens: You get a big winner because you followed a tip from your neighbor… or your brother-in-law… or you held a stock that was a loser, let it run through your stop, and then it turned around and made some good money.
The reason why it happened isn't that important.
What did happen is that you made nice profits in a trade or investment that wasn't part of your trading plan.
This is like Moscow's only elephant being killed – it becomes a random, but very memorable, event for you.
But here's what happens next…
You put the strategy that has been working for you on the back burner, or you abandon it all together.
All of your thoughts are consumed by your own private elephant – that big memorable trade.
You want to recreate it, even though there's no evidence that you can.
You become obsessed by one stock that gave you that great win, or you try to find more hot tips from that same neighbor… or his broker… or his goldfish.
All the while, your good, faithful strategy keeps churning out predictable profits.
And then reality starts to set in…
You find out that there is not another magical tip for monster profits coming from your neighbor.
There was just the one elephant after all.
This is a common problem for traders. Like the Moscow professor, our thoughts and actions become clouded by one recent event.
But how, as investors, can we fight back against this innate bias?
Well, I've put together three ways we can combat this "single elephant" problem…
About the Author
Nationally recognized technical trader. Background in engineering, system designs, and risk reduction. 26 years in the markets.