Why Negative Thinking Makes You A Better Investor

What does going into space and investing in the stock market have in common? Both activities engaged in a high risk, high uncertainty environment. Whereas astronauts have to deal with the risk of 526,000 gallons of propellant blowing up beside them during takeoff or the shuttle disintegrating during re-entry into Earth’s atmosphere at 7.8 km per second, investors have to deal with the risk of changes in the business competitive landscape, permanent loss of capital, psychological misjudgment, and the unknown-unknown. If that is the case, is there something we can learn from astronauts on how to deal with risk and being ready? Plenty.

It is easy to picture astronauts as cowboys and risk-takers like Bruce Willis blowing up asteroids in the Armageddon movie. In reality, it is the opposite. Chris Hadfield, a Canadian retired astronaut, wrote in An Astronaut’s Guide to Life on Earth that one of the most common questions astronauts ask themselves is, “Okay, what’s the next thing that will kill me?” When astronauts are not on a space mission, they’re training in deep pool, simulators and mission planning. They prepare for all kind of eventualities on what can possibly go wrong so they know what to do in those high risk situations.

“Training is something we do to reduce the odds that we’ll die.”

Similarly, investing is first and foremost about managing risk (not making money). Just as astronauts don’t go into space with a hope that everything will turn out as planned, you don’t go into a position only to ask “Should I hold or sell?” after the share price has fallen by 50%. You have to pre-empt it. In other words, you need a plan.

“A lot of people talk about expecting the best but preparing for the worst, but I think that’s a seductively misleading concept. There’s never just one ‘worst.’ Almost always there’s a whole spectrum of bad possibilities. The only thing that would really qualify as the worst would be not having a plan for how to cope.”

Whenever you buy a stock, you’re making a forecast. You’re thinking there’s a good chance to earn a satisfactory return (from dividends and share price increase) based on certain assumptions about the business. But that’s not investing. Investing is being ready to deal with a whole range of negative possibilities as they arise. The emphasis here is about avoiding the downside of not having a plan. When you have a plan, or an exit plan, you can perceive the market more objectively and reduce the likelihood of personalizing your position through confirmation bias. You’re also less likely to get surprised and panic when something goes wrong. What happens when you panic? You make stupid mistakes. Being prepared is more than knowing what to do in a bad situation; it prevents you from making things worse.

“Having safety procedures down cold might save my life someday, and would definitely help me avoid making dumb mistakes that actually increased the risks.”

Rushing to sell everything during a market turmoil is a classic example of unwittingly adding more risk to a bad situation. This is the reason why knowing what not to do is far more important than knowing what to do. If you can identify 20% of your mistakes that contribute to 80% of the losses and stop doing them, your return will improve exponentially.

Now, you might think all these negative thinking is depressing. At this rate, we are probably not going to end up buying any stocks. But it is actually the opposite. Instead of being paralyzed by fear, negative thinking is liberating. It makes you more productive by becoming a better thinker.

“Nothing boosts confidence quite like simulating a disaster, engaging with it fully, both physically and intellectually, and realizing you have the ability to work the problem. Each time you manage to do that your comfort zone expands a little, so if you ever face that particular problem in real life, you’re able to think clearly.”

Negative thinking is a form of premortem. Whereas postmortem is an examination carried out by coroners to identify the cause of death, premortem study an incident before it occurs. In a premortem, you start with a hypothetical bad scenario (i.e collapse in sales volume or revenue) and you work your way backward from the future to the present by identifying a series of minor events that lead to the major event. Do you know why some people are more vigilant than others and able to act swiftly in a dangerous situation? That’s because they have spent their time thinking through how to handle every conceivable situation. They’ve done the drill in their head, “Okay, if this happens, this is what I’m going to do. But if that comes up, I’ll do this instead.” Along the way, they pick up subtle cues that improve their situational awareness. So when the **** hits the fan, they don’t think, they just act.

Another important source of negative thinking comes from seeking out contradictory opinion.

“In any field, it’s a plus if you view criticism as potentially helpful advice rather than as a personal attack. But for an astronaut, depersonalizing criticism is a basic survival skill. If you bristled every time you heard something negative—or stubbornly tuned out the feedback—you’d be toast.”

You’d be toast as well in investing if you see your own opinion as a trophy to be cherished instead of something to be destroyed as fast as possible. It is about cultivating a “What if I’m wrong?” mindset. When you take into account both supporting and opposing evidence and weigh them accordingly, your judgment is going to be more accurate. You reduce the probability of being wrong and increase the probability of being right.

Negative thinking is part of having the humility to acknowledge that things are harder than it looks. Many things are going to turn out differently from what we expected so it’s better to over prepare than under prepare. You want to always think about “What is the characteristic of the business?” What can hurt the business or my investment thesis? At what point will the advantage of the business become its Achilles’ heel? You want to kill your ideas first. A good rule of thumb to find out if you’re well prepared is whether your list of ‘what can go wrong’ is longer than ‘what can go well’. Humble yourself before the market humbles you.

“Feeling ready to do something doesn’t mean feeling certain you’ll succeed, though of course that’s what you’re hoping to do. Truly being ready means understanding what could go wrong—and having a plan to deal with it.”

Notes

Hadfield, C. (2015). An Astronaut’s Guide to Life on Earth: What Going to Space Taught Me About Ingenuity, Determination, and Being Prepared for Anything.