Why do the good methods of top students become money-losing habits in the stock market?

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Why Can't You Control Your Hands?

Everyone has heard of Buffett's punch card theory:

Suppose you have only one card in your life with 20 punches. Each time you make an investment, you punch a hole. Once the card is full, you can't make any more investments. This emphasizes the concept that investors should carefully select opportunities and hold for the long term.

However, in actual investment, most people can't control their hands.

Why is this the case? The answer may be very simple:

The stock - trading population generally has a relatively high level of education. From primary school to university, they have gone through more than a decade of exam training. Long - term exams will shape an effective survival strategy in people's minds, making you "know all the answers and guess right all the time".

But this "exam mindset" in investment will actually lead people in the opposite direction, away from what Buffett repeatedly emphasizes:

What matters most in investment is not how many opportunities you seize, but how many mistakes you avoid.

Where does the problem with the exam mindset lie?

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The Answering Strategies We Learned in the Past

Many people may have left school for many years. Let me help you recall the "exam strategies" back then.

The biggest feature of an exam is that it starts from zero on a blank paper. You get points for correct answers, and there is no penalty for wrong answers. The final score depends on the correct part.

The rule of no penalty for wrong answers results in the biggest feature of an exam being "zero - risk". The exam should use the simplest and most straightforward answering strategy:

You must fill in every question. Never leave a question blank. Guess if you don't know.

For example, for a four - option multiple - choice question, if you have no idea at all, the probability of guessing correctly is 25%. If the question is worth 1 point, the expected value of answering this question is 0.25 points. If you can eliminate one wrong answer, the expected value will rise to 0.33 points.

For a subjective question, the rule is usually to give points according to the steps. Even if the final result is completely wrong, as long as the previous steps are correct, you will get corresponding points for those steps. Whether you know it or not, fill in as much relevant content as possible. There will always be some correct parts. If you get 2 points for each correct point, for a 10 - point subjective question you don't know, the expected value of the correct answering strategy is at least 2 points.

On the premise that the cost of guessing wrong is zero, the expected value is always positive. Sometimes the number of questions answered is more important than the accuracy rate. "Brute - force answering" is the best strategy.

The larger the total number of questions, the greater the potential upper - limit return. Then the number of questions answered (i.e., the answering speed) becomes more important.

At this time, time is score. Every question you don't know is like a gift from God. When you encounter a difficult question, choose an answer immediately and never look back. Never leave a question blank.

You should also "trust your intuition". Don't revise the answers of guessed questions repeatedly. Don't over - think. It not only wastes time but also may change a potentially correct answer to a wrong one.

In a zero - risk environment, people will develop a tendency towards "quick decision - making and daring to take risks". They only see opportunities and ignore risks, trying to seize as many as possible. This is a common tendency among many students when they start stock trading, and it is also an important reason for investment losses.

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Investment is First a Score - Preservation Game

Comparing with an exam, the rules of investment are as follows:

The starting point is your original capital. Your capital account is like a full - score paper waiting to be answered. The rules are:

For a correct answer, you get points;

For a wrong answer, you lose points;

If you don't answer, your score remains unchanged.

Moreover, there is no syllabus for the investment exam. The number of questions is infinite, and there are "out - of - syllabus questions" everywhere.

At this time, the most core part of the answering strategy becomes something you never considered in school - risk management.

Take the most common four - option multiple - choice question as an example. Suppose the rule of this question is that you get +$10,000 for a correct answer and -$10,000 for a wrong answer. The answering strategy can be divided into four situations:

Situation 1: You have no idea at all. The probability of guessing correctly is 25%

Expected value calculation: 0.25 (probability of correct answer) × 1 - 0.75 (probability of wrong answer) × 1 = -$5,000

The correct strategy is: Never touch it! The expected value of blind guessing is a loss of $5,000 each time.

Investment is not about academic research. Not understanding itself is a clear answer.

Situation 2: You can eliminate 1 wrong option. The probability of guessing correctly is about 33%

Expected value calculation: 0.33 (probability of correct answer) × 1 - 0.67 (probability of wrong answer) × 1 = -$3,300

The correct strategy is: Definitely give it up! Even if you eliminate one option, the expected value of guessing wrong is still a loss of more than $3,000 each time.

Situation 3: You can eliminate 2 wrong options. The probability of guessing correctly is about 50%

Expected value calculation: 0.5 (probability of correct answer) × 1 - 0.5 (probability of wrong answer) × 1 = 0

Strategy: Continue to give it up. Although from a mathematical expected - value perspective, you won't lose, considering transaction fees and slippage, you will still lose, and you will also waste time on thinking.

Here, it should be noted that after giving up answering questions consecutively, many people often urgently need a big question to "save the day". If the "score" of this question is high, they will tend to take the risk of losing points to take a gamble.

In actual investment, many people who have suffered repeated heavy losses often become overly speculative. They choose some highly volatile (equivalent to high - score) targets without much confidence (50% probability) and use leverage to take a chance.

This is a very irrational behavior. The more you lose, the calmer you should be. After all, you don't have a chance to make another mistake.

Situation 4: The only worthwhile opportunity

You can eliminate two wrong answers, and you have an obvious preference for one of the remaining two answers.

In the investment - rule exam, it is no longer a "score - grabbing game" but a "score - preservation game". Risk management becomes the first thing to consider in investment, with two characteristics different from ordinary exams:

Characteristic 1: "Leaving blanks" is a standard feature of high - scoring players

In an ordinary exam, a lot of blanks usually mean a poor student. But in the investment - rule exam, leaving questions blank often represents rationality. A high - scoring answer sheet must have a lot of blanks.

Characteristic 2: The elimination method uses "presumption of guilt"

As long as you don't understand, it's not an opportunity. Only do the questions you are absolutely sure of. Any option with a "guessing" or "feeling - like" element should be firmly rejected.

In an exam, you try to answer as many questions as possible. In investment, you try to give up as many as possible. Less is more. This thinking is the "punch card theory" summarized by Buffett earlier.

In an ordinary exam, time equals score. You need to think quickly when reading questions, trust your intuition, and choose the first - thought answer if you can't decide.

But under the "less - answering strategy" in investment, you should allocate more time to risk assessment. If it takes an average of 2 minutes to answer a question, then 1 minute should be used to assess the risk. This one - minute investment is very worthwhile as it can save time on most questions that are not worth answering and allow you to answer the questions you think are worth answering carefully. Once you decide to answer a question, you should try to be as correct as possible and eliminate any possibility of carelessness.

Of course, risk management can only make you a qualified investor. To become a "master", you need to grasp a more core judgment indicator - expected value.

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Masters Only Look at Expected Value

The previous risk management is to judge whether the expected value is positive. To become a master, the expected value not only needs to be positive but also as large as possible.

Taleb believes that most risks in investment are asymmetric risks.

What does this mean? If we regard investment as an exam, the scores and deductions for each question are not symmetric. For some questions, the points for a correct answer far exceed the deductions for a wrong answer. For some questions, the deductions for a wrong answer far exceed the points for a correct answer.

Under this "asymmetric risk", the size of the expected value is often contrary to intuition.

Situation 1: High probability of winning but low odds

For a very simple question, the probability of your correct answer is 90%, but you can only earn $10,000. The probability of a wrong answer is 10%, but you will lose $100,000. The final expected value is still negative, and you shouldn't answer.

For another very simple question, the probability of your correct answer is 70%, but you can only earn $10,000. The probability of a wrong answer is 30%, but you will lose $20,000. The final expected value is positive, but only $1,000. It's at least not worth spending a lot of time on.

There are many companies in the market that are popular in the industry, have good fundamentals, and reasonable valuations. However, because their fundamentals are well - known and market expectations are high, everyone is talking about them, and people around you have invested in them to some extent.

This is an opportunity of "a high probability of being correct, but the deductions for a wrong answer are far higher than the points for a correct answer".

If the performance fails to meet expectations, the stock price is likely to plummet. Or, even if it meets expectations, if there are better "newcomers" in the market, the stock price may not rise but fall.

Situation 2: High odds but low probability of winning

Conversely, if the probability of a correct answer is 30%, you can earn $100,000. The probability of a wrong answer is 70%, and you only need to lose $20,000. The expected value is $16,000.

Such opportunities are more common in a bear market. In a bear market, the overall market trend is downward, and the probability of success when making an investment is relatively low. However, if a company's fundamentals reverse, the upward potential is often much greater than the downward potential.

Under this "odds - first" investment system, although mistakes are made most of the time, it can still make money in the long run. The significance of high odds is that the gains from one correct investment can cover the losses from multiple wrong investments.

Investment is to find the balance point that maximizes the expected value between odds and probability of winning.

Situation 3: Heavy - position betting

Under the principle of risk management priority in the previous chapter, you should try to find the questions you can answer. As long as you judge that the expected value is positive, you can answer and try to answer more questions. Finally, you can at least reach the market average level.

However, if you want to become a master, hard work alone is not enough. You need to look for opportunities in high - score questions and have a reasonable time - allocation strategy.

For a not - too - difficult but very complex question, you spend 10 times more time than on other questions. The probability of your correct answer is 55%, and you can earn $1,000,000. The probability of a wrong answer is 45%, and you will lose $800,000. The final expected value is $190,000, while the expected value of a normal question is only $5,000.

This question is reasonable in terms of expected value, but you must have a reasonable answering strategy, that is, give up a large number of questions with a positive but relatively small expected value.

Whether it is heavy - position betting on a certain track or long - term focus on a certain industry, it reflects this strategy. Packing and researching multiple targets in the same industry for investment and concentrating heavy positions is to artificially create high - score questions.

Another strategy is to hold a long - term heavy position in a target with long - term growth potential that is worth in - depth research and tracking. This extends the time and uses the compound - interest effect to create high - score questions. Moreover, this method can also artificially increase the odds because the upward and downward potential of excellent companies in the long term is asymmetric.

Situation 4: Expected difference and cognitive difference

If there is such a question, you will definitely not miss it:

For a not - too - difficult and not - too - complex question, you don't spend much time, and the score is not low. The probability of your correct answer is 60%, and you can earn $100,000. The probability of a wrong answer is 40%, and you will lose $50,000. The final expected value is $40,000.

Many people will say that there are no such questions with both high probability of winning and high odds.

Actually, it's not the case.

This involves another question that many people like to ask: How do you know the probability of answering a question (I believe many people who don't read this far will ask this question in the comments below)?

In fact, no one knows. The biggest feature of investment is that probability is not objectively given but subjectively estimated.

Therefore, what really matters is not the formula but whether your judgment is more accurate than the market.

For example, for the above question, if the market's judgment is that the probability of success is 50%, it won't make an investment, and the valuation won't be pushed up. If you judge the probability to be 60% after research, you can make a decision to buy.

Cognitive difference is the main source of excess profit. If your judgment is exactly the same as the market's, there will be no excess return for this question.

Investment and exams are the same in this regard. When everyone knows the answer, this question has no differentiating power. But the difference is that in an exam, you must answer and be careful not to make a careless mistake. In investment, if you want to become a master, don't waste time on such mediocre questions where you have no advantage.

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What Matters is Your Expected Value

Let's summarize first:

In school, you learned