Investment Psychology

Question 1

Explain the psyche

Answer 1

The theory uses the Greek word Psyche to refer to the full human mind in its widest sense. It can be translated to mean Mind or soul.
The simple tripartite model of the Psyche we can study makes it up of three parts: Nous, Logos, Pyr

Question 2

Define Nous

Answer 2

mind, thought or imagination for reality, intuition, reflection and the mind’s eye. It’s the mental picture of the world the individual is using. Considered the most important part of the psyche. A rational mindset implements the mind’s intuition

Question 3

Define Logos

Answer 3

logic or rational thinking. The function of logos is to condition the mental picture created by Nous. Logos is logic everyone understands - outsiders find logical also

Question 4

Define Pyr

Answer 4

Pyr - Fire in the belly or impulse and drive. It is the energy used in and by the psyche

Question 5

Define the ego in the context of investment psychology

Answer 5

An individual sees the world partly the way the world is and partly the way they are. Ego is a lense or filtwer through which a person sees the world. An individual’s Ego can defend them from realities that they don’t like and only the individual can open their eyes to these realities.

Question 6

What is a healthy ego and an unhealthy ego

Answer 6

A healthy ego means a person sees the world as it really is and constructively tries to engage with the world
An unhealthy ego means a person uses degrees of self-deception to excuse or justify their actions to make themselves feel better about the world - everyone does this, it’s just getting to know to what extent we do it.

Question 7

When do we hear ego talked about and what does a big ego or small ego mean

Answer 7

In ordinary conversation, individuals can sometimes be distinguished as having a ‘big ego’ or a ‘small ego’, but in investment psychology, the distinction is drawn between ‘healthy’ and ‘unhealthy’ Ego.
If an individual has a ‘big ego’, they have higher self-regard, and a greater sense of self, then they are more liable to ego-defence mechanisms being activated to protect their high self-regard. But it is possible to have a high self-regard and a healthy ego.

Question 8

Define a rationalisation

Answer 8

When an individual makes a judgment based partly on the way they are and partly on the way the world is, this is referred to as a rationalization

Question 9

What effects the likelihood and severity of our rationalisations in a situation?

Answer 9

The more emotional we feel in a certain scenario the higher our expectations of a certain outcome

Question 10

What are ego defence mechanisms and why do they occur?

Answer 10

Ego defence mechanisms are a type of rationalization caused by high emotion and high expectations of something that didn’t happen.

Question 11

How do we measure rationality?

Answer 11

Rationality is considered to be a spectrum rather than an absolute. At one end of the spectrum is Logos: dispassionate, neutral reasoning which in theory could be understood by all, while at the other end would be factually incorrect rationalizations, heavily distorted by Ego.

Question 12

What is the idea of the hill depicting?

Answer 12

Progressively meeting our needs in life is an uphill battle and it is harder to progress than it is to regress.
We ascend the hill according to how much we require of ourselves
“Nothing any good isn’t hard”

Question 13

What are the challenges people face engaging Nous

Answer 13

Involves opennes, vulnerability, not veiling the truth - uncomfortable situtaion
Individuals ego can fight against self reflection as it wants to feel good
Nous threatens ego defense mechanisms

Question 14

What are the challenges engaging Logos

Answer 14

Requires discipline, lack of distractions and taking everything in
The capacity to apply Logos is limited by the extent they applied Nous
Ego will always want a less realistic picture of the world

Question 15

What are the challenges of engaging Pyr

Answer 15

Needs motivation
The ego is typically inclines to risk aversion -risk not fully negaging pyr
Not engaging nous or logos then Pyr can cause problems with impulsive behaviour not thinking realistically

Question 16

What are challenges with engaging the whole psyche?

Answer 16

• The openness, uncertainity and doubt that aid the Nous conflict with the stability & safety of the Logos.

-Nous requires a certain amount of disengagemnet from the Pyr. Logos requires discipling the Pyr

Question 17

Describe intrinsic vs extrinsic motivation

Answer 17

Intrinsic - using your heart
Extrinsic - using your ego

Question 18

What is a narrative

Answer 18

Big picture - the story
It’s important to note the narrative needs to be deep enough to show the big picture without taking sides. A simple to shallow narrative usually has another simple or shallow narrative contracting it. Shallow narratives can result in persuasive but erroneous speech prevailing over reason and logic

Question 19

When investing how can we balance ego and logos

Answer 19

When investing an investor’s Logos needs to be ego-critical to avoid the rationalizations that can arise this Logos needs to be somewhat pessimistic if anything to counteract the EGOs idealized view of the world

Question 20

Describe the conformist

Answer 20

The individual who does not engage their Psyche beyond their rationalisations, will passively rely on the narratives (Nous) and the analyses (Logos) of others. They can do so by conforming to a variety of norms and ‘accepted wisdom’.
Provides ready-made templates for understanding, coordinating and engaging with the financial markets and they lower the cognitive load of engaging with the world
Become part of the Group-ego.

Question 21

What are a conformists ethics?

Answer 21

They have some degree of expectation that others give things to them or do thing for them
Only carry out analyses in their narrative, challenging the narrative is too dangerous
Freedom for them is less responsibility
Adapting to the environment
Action and courage tend to be absent - want someone else to do this

Question 22

What is a EMH claim?

Answer 22

The EMH claims that asset prices fully reflect all available information. The consequence is that stocks always trade at their fair price so it is impossible to consistently pick individual stocks that will ‘beat the market’.

Question 23

What are the different deficiency points in EMH from the perspective of a competitive investor

Answer 23

Asset prices do not reflect all the available information
EMH can be seen as a group ego defence mechanism
Investors with market power are not considered to fit into this

Question 24

How does one go about Creating an investment narrative with a competitive advantage

Answer 24

Better understanding than average of the non-Logos behavior of other investors
Deep narrative - more capabilities for Logos
Recognition of deficiencies in current consensus
Allowance for the expected behavior of investors adhering to EMH and CAPM
Recognition and understanding of likely behavior of the bigger players in the market - winning and losing player

Question 25

Characteristic’s of an astute investor

Answer 25

Understanding implication of opposing theories like EMH
Exercises patience and humility
Considers it essential to have a disciplined psychological apporach to investing
Actively and critically looks at the world and creates a critical narrative
Creates a deep narrative when looking for causes and effects
Digs deeper into media narratives
Creates their own narrative that is a realistic as possible - questions existing narratives ina progressive manner
Are disciplines with losses
Learns to improve their narratives continuously
Ability to persist and start over
Understands the advantages and disadvantages of diversifying

Question 26

Comparison of consensus vs competitive investor

Answer 26

Consensus Investor:

Trusts market prices as reflecting collective wisdom.
Believes in the Efficient Markets Hypothesis (EMH).
Focuses on rationality, with some behavioral biases.
Sees markets as driven by randomness.
Values stability, persistence, and diversification to reduce risk.

Competitive Investor:

Views market prices as reflecting ignorance.
Questions the EMH and believes many participants lack skill.
Seeks causes and effects, digging deeper into narratives.
Emphasizes winning in uneven markets and adaptability.
Favors concentration over diversification to build wealth