Turn on the TV or flip open the business section of a newspaper and you’d think the world was coming to an end. Today’s crisis is that the Chinese market is “falling off a cliff” and that oil prices are “crashing.” You see graphics like the one below showing a blood-red tinge, a bellowing bear, and red arrows slashing downward.


With this kind of stimulus, the same thing happens to me that happens to everyone.

Processes are triggered within our minds that neuro-psychologists associate with what they call the “X-System.” This is the primitive, animalistic fight-or-flight messages that tell us we had better do something quick or we’ll be in trouble. Our heart rate increases as does our blood pressure as our bodies prepare to escape the bear!

Running away is a sensible reaction for a hunter-gatherer seeing a hungry bear, but it is very damaging to modern people trying to make investment decisions. A case in point is the oft-repeated findings that average fund investors only made 2% annual returns while the mutual funds they owned returned 8% during the same period. The reason? They sold out of the funds at the wrong time and waited too long before gathering up the courage to get back in.

The reliance on X-System processes the damaging behavioral biases they produce is the main topic of discussion in our IOI 102 course — an Introduction to Behavioral and Structural Biases. Many times, it is not our reasoning that is the cause for disappointing investing returns, but rather our irrational behavior that runs contrary to our original reasoning. The IOI 102 course shows how to avoid these biases in ourselves while profiting from these biases when practiced by others. (In IOI 102, we also look at “structural” factors related to how the way professional market participants are compensated and encouraged to talk about investments often work against the long-term interests of principal investors).

What did I do when the market was “crashing?” First, I shut off the TV and stopped checking securities prices on the Internet. Then, I forced myself into C-System mode (the C-System is the opposite of the X-System and is used for advanced problem-solving and analytical tasks). U.S. shoppers seem confident, looking at holiday sales. Europe seems to be pulling out of its Great Recession. Today, we learned that job growth in the U.S. is looking a bit stronger. On the other hand, continuing low commodity prices are probably responsible for the slowdown in activity shown in the January ISM reading that do spell bad news for some important industries in the U.S.. So a mixed bag, but on the whole, it doesn’t seem like the end of the world.

After taking time to consult my C-System, I realized that I had still not “rolled” my position in GE (which was set to expire next week) and that, on a price-to-fair value basis, my old standby Oracle was looking even more attractive than GE at this point. So I rolled 60% of my deep ITM GE call options out to 2018 and used the profits from the remaining 40% to open the “levered long” position on Oracle that I described in a Tear Sheet in early October, but wasn’t quick enough to execute on then. It looks like my sold puts on Oracle will also expire ITM, meaning Oracle will be a much larger proportion of my portfolio. I also decided not to do more with IBM until I had more time to analyze its profit dynamics. The last quarterly results showed a big uptick in OCP (“Owners Cash Profits” — IOI’s preferred measure of profitability) for IBM, but I need to look closer to see where the added profit is coming from and if it is a material sign or just a hiccup.

So how did I escape from the bear? By relying on my rational C-System processes rather than getting trapped in my primitive X-System ones.

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