Outstanding investors spend most of their time waiting

Combining Red and Green.

Here is the full translation of Chapter 17 "Beware of Action Man" from the book:

What is the commonality between a goalkeeper facing a penalty kick and an investor? The answer is: both tend to take action, feeling the need to do something. However, waiting is also a choice, and sometimes holding cash is perfectly acceptable. But for many fund managers, this is still a curse. Perhaps they would do well to remember the advice of Paul Samuelson: investing should be boring. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow.

Imagine you are a goalkeeper facing a penalty kick. You have no idea which direction the penalty taker will choose to shoot. You must make an effective decision at the same time as the penalty taker, whether to dive left, right, or stay in the center of the goal line.

Most professional goalkeepers tend to dive left or right. Surprisingly, in 94% of cases, choosing a direction is the preferred action. However, this is not the optimal solution. If you look at the probability of penalty kicks being saved, you will find that staying in the center of the goal line is actually a wiser choice (assuming the penalty taker's behavior remains unchanged). Goalkeepers show a clear preference for action.

Evidence from experimental markets shows that investors also exhibit a preference for action. For example, in an artificial asset market where basic value is easy to calculate and reselling shares is prohibited, trades above the basic value should not occur. However, repeated experiments have shown a large number of trades occurring well above the basic value. This makes no sense at all. Since reselling is prohibited, people cannot expect to take advantage of a bigger fool for trading. These trades seem very boring—action bias does exist.

Warren Buffett has previously likened investing to an exciting baseball game where there are no umpires calling balls and strikes. Investors can simply stand on home plate and watch the pitches go by, waiting for their sweet spot to come and hit it out of the park. However, as Seth Klarman described, "Most institutional investors feel compelled to swing at every pitch, rather than waiting for the perfect one to hit."

1. The Action-Oriented Goalkeeper

Although not the star of the team during the game, in penalty shootouts, top goalkeepers are all action-oriented. A recent study by Bari-Eli et al. (2007) revealed some interesting patterns when attempting to save penalty kicks. In football (a sport I am basically clueless about), when a penalty kick is awarded, the ball is placed 11 meters from the goal, a simple duel between the goalkeeper and the penalty taker. The goalkeeper must stay on the goal line before the shot is taken.

Considering that in an average football match with 2.5 goals, a penalty kick (with an 80% chance of scoring) can greatly impact the game's outcome. Therefore, unlike many psychological experiments, the stakes here are very high.

The author analyzed 311 such penalty kicks in the world's top leagues and championships. A group of three independent referees was used to analyze the direction of the shots and the goalkeepers' movements. To avoid confusion, all directions (left or right) are broadcast from the goalkeeper's perspective Roughly speaking, the kicked balls are uniformly distributed, with approximately one-third of the balls aimed at the left, center, and right of the goal respectively. However, goalkeepers show a clear action preference, either diving to the left or right (94% probability), almost never choosing to stay in the center of the goal line.

To evaluate the "optimal" behavior, we need to know the success rate from the combination of shooting and saving. Table 17.2 illustrates this. The best strategy is evidently for the goalkeeper to stay in the center of the goal. He saves 60% of shots aimed at the center of the goal, much higher than his success rate in diving left or right. However, far from this optimal strategy, goalkeepers only spend 6.3% of the time in the center of the goal! The behavioral bias exhibited by goalkeepers is clearly not the optimal behavioral pattern.

The reason for this behavioral preference seems to be perceived as a norm. Goalkeepers feel at least some effort when diving left or right, while standing in the middle and watching a ball fall to their left or right would feel worse. Bari - Eli and others confirmed this through a survey of top goalkeepers.

II. Investors and Action Preferences

To introduce evidence of investor action preferences, I must first introduce the field of experimental economics, especially experimental asset markets.

These are great inventions that study people's behaviors in financial market environments - without any complex factors. These markets are very simple - only consisting of one asset and cash. The asset is a stock that pays dividends once per period. The amount of dividends paid depends on the market's state (four possible states). The weights of each state are equal (i.e., the probability of each state occurring in any given time period is 25%).

Figure 1 shows the basic value of this asset. Over time, the expected dividend payments in each period decrease significantly. Now you might think this is a simple trading asset. However, evidence suggests that this is not the case.

Figure 1: Basic Stock Value in Experimental Markets Source: Lei, Noussair, and Plott

Figure 2 shows a typical result of one of these asset markets. The asset is initially severely undervalued, then rises significantly above fair value, and finally drops back to the basic value in the last few periods. This is just a simple bubble formation and burst. What does this have to do with behavioral preferences? Figure 17.2 is from a particularly interesting version of an experimental asset market run by Lei, Noussair, and Plott (2001)

Figure 2: Formation process of bubbles in experimental markets Source: Lei, Noussair, and Plott

In this special version of the game, once you buy a stock, you are prohibited from reselling it. This eliminates the possibility of the greater fool theory driving the bubble. In other words, since you cannot resell the stock, there is no need to buy it at a price higher than its fair value. You cannot sell them to others for a higher profit. In fact, participants are only trading out of boredom! Therefore, investors do tend to take action.

III. Buffett on the Key Plate

The madness of this action preference is directly contrasted with Warren Buffett's advice. He likes to compare investing to baseball, except there are no umpires calling balls and strikes in investing, making the two very similar. Therefore, investors can stand at the home plate, simply watching the pitches go by without having to swing at them. However, as Seth Klarman pointed out in his book "Margin of Safety," "Most institutional investors... feel compelled to invest at all times. Their behavior is like umpires calling balls and strikes, mainly strikes, forcing them to swing at almost every pitch, giving up the choice of how often to swing."

IV. Action Preference Particularly Evident After Poor Performance

The final aspect of action preference is particularly noteworthy—it often intensifies after losses (a period of poor performance in our area of expertise). Zeelenberg et al. (2002) used a loss frame to illustrate the way inaction tendencies turn into action tendencies.

Zeelenberg et al. asked people to consider the following scenario: Stinlan and Strathseff are both soccer team coaches. Stinlan coaches the Blue-Black Legion, while Strathseff coaches E.D.O. Both of them lost the previous game with a score of 4-0. This Sunday, Stinlan decides to do something: send three new players onto the field. Strathseff decides not to change his team.

Both teams lost the game with a score of 3-0 this time. Who do you think regrets more, Coach Stinlan or Coach Strathseff?

Participants saw this statement in one of three forms. Some received the information as described above (i.e., based on the previous loss), while others only received the latter part (i.e., without the previous information). The last group saw a version where both coaches won last week but lost this week.

If the team won last week, 90% of respondents believe that the coach who made changes would feel more regretful after the team lost this week (this is a well-known tendency towards inaction or inaction). However, when both teams lost for two weeks, see what happens (as described above). **Now, nearly 70% of respondents believe that coaches who take no action will feel more regretful—thus, the urge for action preference is exceptionally strong when dealing with losses **

V. Conclusion

Psychology and empirical evidence seem to strongly suggest that investors tend to take action. After all, they are engaged in "active" management, but perhaps they should remember that waiting is also a choice. As Paul Samuelson once said, investing should be boring. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 to Las Vegas, although getting rich in Las Vegas, at the Churchill Downs racetrack, or at the local Merrill Lynch office is not easy.

Legendary figure Bob Kirby once wrote "The Coffee Can Portfolio" (Kirby, 1984), in which investors must buy stocks and then ignore them—he described this idea as passive aggressive behavior.

Kirby said: I doubt this concept is likely to be popular among investment managers, because if widely adopted, it could fundamentally change the ecology of our industry and potentially significantly reduce the quality of life for practitioners in the asset management industry.

The concept of the coffee can portfolio can be traced back to the Old West, where people would put their valuable possessions in a coffee can and then place it under the mattress. Coffee doesn't involve trading costs, management costs, or any other costs. The success of the project depends entirely on wisdom and foresight, used to select objects to put in the coffee can...

What kind of results would excellent fund managers produce without these activities? The answer lies in another question. Are we traders or true investors? Most excellent fund managers are probably investors at heart. But the presence of algorithms, news services, and computers that generate a large number of investment results every day make their behavior resemble that of traders. They start with reliable research, identify attractive companies in promising industries in the long run. Then, based on monthly news trends and various forms and sizes of rumors, they trade these stocks two or three times a year