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scott barlow

Successful investing is often more dependent on mitigating the negative influence of human psychology than on market knowledge.weerapatkiatdumrong/Getty Images/iStockphoto

Capital markets professionals have been passing around copies of Sun Tzu's 2,000-year-old strategy treatise The Art of War since it was mentioned in the movie Wall Street in 1987. In my opinion, however, the testosterone-drunk trading-floor environment usually leads them to focus on the wrong aggressive and punch-up parts of the book.

My pick for the most pertinent quote from The Art of War leads directly to my first post on strategic advice for Canadian investors for 2016.

"If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle."

It's a bit dramatic to equate the TSX with an "enemy" (although it's become much easier in 2015), but the advice still holds. Successful investing is often more dependent on mitigating the negative influence of human psychology than on market knowledge. Applied to investing, Sun Tzu's "know yourself" means understanding the specific emotional biases that sabotage investing decisions.

Practically, my advice for investors is this: Revisit every losing investment in the past few years and try to imagine the emotion that dominated the decision-making process. The most common options are fear (selling when asset prices are bottoming), herding (chasing hot, popular market sectors such as precious metals and taking too much risk) and confirmation bias (only reading market advice you already believe).

The Psy-Fi Blog is dedicated to explaining all of the ways psychological tendencies lead to bad investing outcomes, and there are a lot of them. The specific post "The Latticework" provides links explaining the hundreds of ways in which the human brain is so terribly suited to investing. I suspect that any investor reading through the list will be mentally saying, "Yup, I've done that, yup, I've lost money that way," all the way through to the bottom of the list.

I suspect that anchoring, which Psy-Fi calls "the mother of all behavioural biases," is the most pervasive investing mistake among Canadian investors in the current environment. Simply put, anchoring involves comparing the current price of an asset to a price from the past instead of looking forward to assess where the price is going from here.

The most obvious example of investor anchoring occurred in the Canadian energy sector in 2015. Early in the year, investors ignored glut conditions in the North American oil markets and bought energy stocks in the belief that, "they're down 45 per cent from last year. They must be cheap!" These investors were anchored to a 2014 asset value that reflected an environment that no longer existed.

The value of the loonie is another area in which the tendency of anchoring is evident among domestic investors. Time and again, I've heard, "I can't buy U.S. equities because the Canadian dollar's down almost 20 per cent from last year." These investors are making decisions based on the anchor of previous loonie values when what really matters is what will happen in the future – the relative attractiveness of Canadian against U.S. investments.

For me, "know yourself" means guarding against impatience. I have bought into trends such as biotechnology too early and sold them way, way too early, leaving the bulk of gains on the table. More painfully, I also tend act too quickly before negative market trends fully play out. The worst investment mistake I ever made was buying technology stocks in 2001 with my thought process anchored to peak stock prices in 1999 and taking a major portfolio beating in the next few years when the tech sector continued lower.

We all have psychological biases and almost all of them negatively affect our investing decisions. Knowing what they are is only the first step, but an extremely important one as we enter the new year.