Representative Bias

Happy New Year 2011! Hope this year is another fruitful year for our local stock market!

Today I’ll continue with last week’s topic on behavioural finance. Today I’m going to talk about “Representative Bias”. Representative bias refers to the human bias in us that we often stereotype certain things with similar characteristics with similar outcome. For example, whenever we see a beggar, he or she must be poor, that’s our first thought. However, there are cases where some of them live in big houses! Another example, bad drivers – if you see a bad driver, it must be a lady! So all these are stereotyping!

When this theory applies to our stock market it becomes like: politically linked stocks but no profits, buy! Because it sure goes up! Datuk so and so’s company – buy! He usually “goreng” his own stocks! Hence we tend to stereotype the stocks with similar nature such as traits like politically linked or owned by some famous VIP, their stocks usually can soar very high, and we neglected other important facts about those stocks!

The outcome of this type of investing style is that you’ll see your own profit going through big ups and downs. I’m not saying this is wrong, in fact when it comes to investing styles, there is no right or wrong strategies because different individuals with different risk preference and resources, will choose the strategies that suit them most. But however, if you are a value investor, this may not be the right style for you because value investors focus on the true value or the intrinsic value of the particular company.

Investment is an art, not a science. There are no fixed rules, different market condition you’ll employ different strategies, but no matter how you invest, you must have some basic principles. The main difference between rules and principles is that rules refer to some detail fundamental and technical analysis such as financial ratios and technical indicators. However, principles of investment refer to the bigger picture of investment, it guides you what you are going to do with your investment “as a whole”. For example, must diversify your portfolio, must not invest with borrowed money, and so on.

Hence, the next time you want to buy a particular stock because of its superficial information, make sure that you are just diversifying ‘some’ of your money not ‘all’ into it!


Happy investing,

Pauline Yong