Every now and then some more or less famous investor is quoted with some common wisdom that rarely gets challenged but which in my opinion is total nonsense if used in the wrong context.
Example: “Picking up Nickels in front of a steam roller” should be generally avoided
This is a comment I often here when I discuss certain special situations like for instance the Stada case.
John Hempton has a very interesting post on when to average down into a stock.
As a summary, one should not average down into a stock if
- a company has a lot of financial leverage
- a company has significant operating leverage
- the company is in danger of becoming obsolete
I think this is already a pretty good advice, as a counter example he gives Coca Cola where one can average down “without much risk”. As this is a very interesting topic, I wanted to contribute my 5 cents to this:
Behavioural biases at work
In my experience, averaging down is often motivated by a couple of behavioural biases.
The major bias which “helps” investors and especially professional ones to average down in the wrong cases is in my experience the “over confidence” bias.
This is a somewhat “off-topic” post but at the end there will be a turn to investing, I promise !!!
A Swiss magazine published an article on the Weekend, where a “Data scientist” claimed that a method that he developed had made Donald Trump President.
This method, which claims to identify (and of course influence) people by 5 basic character traits was used by a company called “Cambridge Analytica” in order to secure Trump’s victory. And by the way, they were responsible for Brexit too. The article seems to be quite popular, I received the link 5 times over the weekend from very different sources
There are a couple of Youtube videos about Cambridge Analytica, for instance here. But there is a longer one which is more interesting
In the video from September, they are claiming that they managed to make Senator Cruz popular from scratch. They also claim that they can segment down to very small groups and deliver them the right message in a way that will more or less “guarantee” results. As an example they showed how they targeted very small sub groups in Iowa with targeted ads about guns to make them vote for Cruz in the caucus.