Should You Trust Popular Trading Proverbs?

MARK RIEPE: It's better to be safe than sorry. Or is it­? Because nothing ventured, nothing gained, right?

Sure, opposites attract, but don't birds of a feather flock together?

If out of sight means out of mind, then how does absence make the heart grow fonder?

While most of us are familiar with these expressions, many write them off as simple clichés, too ripe with contradictions to be given any credence. Others might find them helpful when used in context, like idiomatic tools for making a point. Either way, they're ubiquitous. 

I'm Mark Riepe. I head up the Schwab Center for Financial Research, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgement.

It's no secret that repetition is a powerful concept across countless applications. Our habits, skills, and discoveries are all in some way tied to it. As Aristotle said, "We are what we repeatedly do."

I love that line, but there's just one little problem: Aristotle didn't actually say or write it.

Yes, the quote is widely attributed to Aristotle, but it was actually written by the author Will Durant, who was writing about Aristotle.

Misconceptions like these can thrive on repetitions and eventually be regarded as the truth.

It turns out that this process has a name. It's called  "illusory truth" and has been documented many times, starting with a study in 1977.

In more concrete terms it's now classified as a bias defined as "a willingness  to believe something heard repeatedly despite any additional evidence or lack thereof."

Two examples are that Vitamin C prevents the common cold or that most body heat is lost from the head. Both ideas are inaccurate but become widely believed through their ubiquity. 

Of course, sometimes an oft-repeated axiom, maxim, or cliché has at least a kernal of truth to it, while others make sense and are true in some situations, but not others.

The world of finance and investments is no exception to the forming of popular axioms and the misconceptions that can go along with them, especially the practice of stock trading.

Traders are well-supplied with frequently repeated sayings that speak to perceived data patterns or work to gut-check choices plagued by their own emotional biases.

Here to unpack a handful of these axioms is Nathan Peterson, director of derivative analysis at the Schwab Center for Financial Research. He's been with Schwab for going on 19 years and has been quoted by AOL Money & Finance, CNBC.com, and MarketWatch.

Nate's a lead writer of a daily publication here at Schwab called "Today’s Options Market Update," and on most Fridays he also writes our "Weekly Trader Outlook" publication.

Nate, you're a busy guy, so thanks for tearing yourself away from your computer screens to talk to me.

NATHAN PETERSON: Hey, thanks, Mark. It's great to be here. 

MARK: Before we get into kind of the meat of things, maybe just tell me a little bit about how you found your way into trading in the first place.

NATHAN: Sure. So back in the late nineties, during the boom there, I was fortunate enough to come into some inheritance, and my brother suggested that I purchase stock in a small computer company you might have heard of called Dell.

Obviously, Mark, during the nineties, all the tech stocks, they performed so well, and because of that, it really made me look at why stocks go up, and I began to ask whether I should diversify into some other holdings, or perhaps there's a better place that I could put the money, in addition to Dell.

And so that really set me off into my investing/trading journey. And, you know, Mark, I got to tell you, I remember when I was surfing through the channels before I got into investing, I'd go through CNBC, and I'd see these weird symbols at the bottom of the screen that kept on scrolling by, and I was just … it was hieroglyphics to me.

I had no idea what any of that stuff meant or why anybody would watch that channel. And then as I got into trading, it was on the TV 24/7, and my roommates hated me for having that going on all the time.

MARK: Well, I think … I think that's a great story, and Dell is probably not a bad company to sort of start your investing journey with. My actual first investment in high school with two friends was we bought three ounces of silver, and in the late seventies, that was not a good time to be buying silver. So there you go. I used the term trading in my question and we talk a lot about investing here on this on this show—so what's the difference between trading and investing? 

NATHAN: Sure. It's absolutely important to understand the differences, the distinctions between the two. And, you know, an easy way to think about it is when you're trading, you're essentially renting stock. And when you're investing, you are owning stocks. 

So long-term investors generally have an understanding of what the company does, how it makes money, whether the fundamentals are improving or not, whether the management has a history of execution, and what are the growth prospects going forward.

They do their due diligence before putting their money to work. And conversely, traders are really looking for setups. They're not concerned as much with fundamentals. They're looking at price. They're looking at catalysts. They may not even care what the company does. They're more concerned with what the trend is, what the setup is, what the catalyst is, and how can I get in and out with a profit.

MARK: Sometimes we'll talk about people as traders and other people will put the label on them that they're an investor, almost as if they're kind of separate species. Can in fact, under real-world conditions, can a person really be both a trader and an investor? 

NATHAN: I'd say many are both, but it is going to depend on an individual's risk tolerance and, you know, whether you have a knack for trading, whether you're very comfortable with trading, and you feel like you have a sense of what the setups might be or what opportunities might come in the near term. So, you know, if you're an investor getting into trading, then I would suggest paper trading or virtual trading before you put any real money to work.

And you know, have a thesis or a strategy, and then test it out, and don't test it for a couple of weeks—test it out over time and then be honest with the results. Have you found a strategy that is successful? And in those instances when the trades were moving against you, did you limit losses? Were you able to get out?

And if you feel confident enough to put real money to work in trading, then you could consider allocating something like 10% or 20% of your portfolio to trading. But you know, Mark, I'll tell you, in regards to that paper trading, it's different than having real money on the line because the emotions come into play. So if you find there's some deviation between your paper trading and your actual trading, take a step back and go back to the laboratory and test some more strategies.

MARK: Yeah, by paper trading, you're talking about using kind of simulated buys and simulated sells as opposed to real money, right?

NATHAN: Absolutely. Absolutely. Spreadsheet it, track it, and then have a sense of, you know, whether it's successful or not. 

MARK:And I think your point about, you know, kind of learning from what your results are, I think that's vitally important. No matter whether you're a trader or an investor. That's an excellent point. 

We're going to be talking about some trading aphorisms, maxims, axioms, whatever you want to call them. But before we get into kind of the specific ones, what role do you see these kind of rules of thumb playing in the life of a trader? 

NATHAN: Sure. Well, you know, I think first it's probably good to acknowledge that there's likely a kernel of truth or wisdom to be extracted from whatever saying if it sustained the test of time. 

And I think it should also be noted that some axioms will apply to investors, and others will be for traders, and vice versa. You know, most of these things originated from someone's experience with investing or trading, and it's especially those instances where they experienced pain or significant losses.

And so I think the intention behind a lot of these, you know, maxims is that they're intended to offer some insight into how the market works and potentially help new traders to avoid some of the pitfalls that their predecessors encountered. 

MARK: Are there any kind of overall words of caution that traders should be kind of keeping in mind as they start learning about some of these rules of thumb?

NATHAN: Yes. You know, I think there's always exceptions to any of these axioms that we cover. You've just got to get really familiar with the various market environments. You could be in a, you know, a bull market, a bear market. We could be in a sideways trend. There's also various themes that will dictate price action, positioning, and that axiom might make sense in one of those environments, but it may not make sense in another.

So you should have a sense of what the dominant market psychology is that is driving the price action currently. 

MARK: Maybe explain that a little bit more: dominant market psychology. What do you mean by that?

NATHAN: Sure. So, you know, at any given time when I refer to dominant market psychology, what I really mean is that the narrative that is driving the money flow in the market, you know, for example, are we in a bull market or a bear market currently?

Where do we stand in the business cycle? So we know that oftentimes the economy is cyclical, we'll be running into potentially a recession, and you might be in that situation more going towards the defensive or secular stance. And then when we're coming out of a contraction into an expansionary business cycle phase, then maybe you might tilt towards the cyclicals.

So you need to understand that, as well as what are some of the macro factors that might be dictating what's the concern for the market? You know, the Fed, interest rates, geopolitical risks, and then beyond that, underneath the covers, there's typically some themes that are dictating a lot of the money flow for investors. You know, if you go back to the internet, when you go back to handheld devices in Apple, or the cloud, or most recently artificial intelligence, just having a holistic understanding of what's really moving the market on a day-to-day basis is important.

All these factors collectively feed into the market psychology and help determine positioning, money flow, investor sentiment towards owning risk assets.

MARK: So let's start digging into some specific ones, and let's maybe start out with the most common one, I think: buy low and sell high. 

And let me say upfront, I'm actually a big fan of this one. It seems to me like telling a sports team to go out there and score more points than the other team. It's just, you know, it's not incorrect, but it's a little bit obvious as well. So, what's your take on it?

NATHAN: Yeah, it does. It sounds almost insulting. Of course buy low, sell high. But I think the origins of this come from the tendency for investors to emotionally chase or buy near the tops of the market and then emotionally sell near the bottom when we go through one of those corrective phases or those bear markets.

So when equity markets or a specific sector or a theme is in a euphoric, bullish phase—you can think of the internet bubble or, most recently, this SPAC or meme bubble that we went through in '21. Oftentimes individual investors on the sidelines develop FOMO, fear of missing out, and they end up chasing these stocks when they are in the latter phase of the rally.

So they're buying near the top. And oftentimes these pushes from the retail crowd that are looking to that, they've been on the sidelines, and they're looking to capitalize on some type of a rally that's been in place. This can actually create some type of a crescendo top because it's as if the last buyers got in. 

Conversely, they hold on. You get a reverse. They're looking at these losses that begin to incur. We go through a corrective downtrend. Selling begets selling, and they're watching these losses that continue to show up every day, and they get tired of those losses, and eventually they capitulate. They give up. They end up selling out of the position because fear is basically dominating them.

So Mark, they're doing the reverse of what this axiom states. They're buying near the top, selling near the bottom. I think that's probably where it came into place. 

MARK: So what are the consequences of this behavior? Ultimately, why does this matter? 

NATHAN: Well, I think it's important to understand that emotions get involved, whether it's greed or FOMO leading to chasing performance near highs or this type of fearful behavior that can often crescendo into a capitulation low for the stock market.

So investors, instead of buying at the top, they're selling at the bottom in the reverse. So it's just important to understand the role that the emotions can play when you're stepping back and deciding what to buy and when to sell it. 

MARK: Nate, you mentioned capitulation a couple of times, and anyone who watches, you know, some of the some of the financial media, you know, at some point you'll hear a strategist saying, "Well, the market hasn't capitulated yet" or "I'm waiting for the capitulation before getting back in." What what does that term mean? 

NATHAN: Sure. So capitulation you can think of, you know, surrender or giving up, and in investing it just really refers to those periods when, you know, the market may be going through some kind of a significant sell off. You know, think about the great financial crisis or the period that followed the dot-com bust back in 2001.

And it generally can crescendo into a point where investors are just tired of watching losses continue to mount, even though they might in the back of their mind feel like, "Long term, I know that the market will recover," their emotions take over. It pulls them into this fear that they don't want to lose anymore. And it comes to a point where they just say, "Get me out at any price. I just can't stand the emotional pain with holding on anymore." 

MARK: That's right. And whenever you hear the phrase "Just do this at any price," you know, that's usually not a good sign. Sometimes buy low and sell high, I've heard it described or used in conjunction with valuation. Could you talk a little bit about that?

NATHAN: Yeah. So this may be a little bit easier to understand if we think about valuation in regards to either an index or an individual security. If I were to have a chart of the … either the trailing or the forward price-to-earnings ratio on the, let's say, the S&P 500® or a stock that I'm interested in, you're likely going to see some variation in that valuation in terms of what the market is willing to pay.

This can vary from stock to stock and from sector to sector. So if you have a sense of what the average valuation for an index or an individual stock is, then you can look at that and take the approach of when it's relatively cheap on a historical basis. Maybe that's when I buy low. And then if we've had a really good run in the markets, and the valuation is now stretched, historically speaking, maybe that's a time when I lighten up.

So then I would be buying at a low relative valuation, selling at a high relative valuation, irrespective of what's going on in the market. 

MARK: We talk a lot about, or we'll use the term "long term" a lot on this, on this podcast. And a lot of that's driven by not only, you know, one's perspective, but also from the fact that, you know, long term, stocks tend to go up, not every individual stock, of course, but the overall market. So does that factor in a little bit how traders should kind of approach what they're doing? 

NATHAN: Absolutely. So I think that we have to acknowledge that the average annual return for the S&P 500, for example, it's around 10% since inception or 7% when you adjust for inflation. And so this just should at first give you some kind of upward bias that stocks generally over time tend to move higher.

This makes sense when you think of it fundamentally that the global economy expands and earnings tend to increase over time as the economy expands. So with this historical context in mind, buy low, sell high. Consider buying stocks when the stock market is going through some type of a correction. They are going to happen. Bear markets will happen. A correction is basically a 10% decline from a recent high, or a bear market would be a 20% drawdown from a recent high.

Knowing that these are going to occur throughout time, and knowing the historical average of that 10% (or 7% inflation-adjusted) return. Maybe it's a good time when we get one of those significant pullbacks to then consider buying low. 

MARK: You know, we started this out by me saying, "Buy low, sell high." You know, it wasn't very important then. It was, you know, kind of frivolous. And then we just spent 7 minutes talking about it. So maybe there's more there than meets the eye, or at least it illustrates your broader point that there's always a kernel of truth in these things that people should pay attention to. 

But let's move on. Let's talk a little bit about "Buy high, and sell higher," which is I think of it as a kind of a fancy way of saying, "Don't worry about valuation too much." So unpack this for us.

NATHAN: Yeah, No, it's a good point. And look, if a stock is making new highs, there's a message that it's conveying to us. I mean, first there's relative strength. Stocks that are hitting new highs are attracting fresh money flow. And this also suggests that this stock is in a price discovery mode as investors are attempting to find a fair value on the stock.

The good news is when you're hitting consecutive new 52-week highs is that the market hasn't quite found that fair value. So the presumption is, though, they're still searching for it. But we know that, at least as perceived by the market, it appears to be valuable or undervalued perhaps. Furthermore, technicals and fundamentals are typically not divorced, so stocks that are in an uptrend ,and they continue to hit new highs, likely have corresponding improving fundamentals, or they're growing swiftly or increasing sales and earnings.

Stocks that are hitting a new high often continue to hit a fresh high in the near future. I think this speaks to the evidence of trends. I put out a daily options blog here at Schwab, and every day I have to go look at the new-high and the new-low list, and I invite any of our listeners to just go and track those 52-week highs on a day-to-day or a week-to-week basis.

And I think you'd be surprised how often you'd see those same names that continue to show up on those lists. It kind of speaks to that evidence of trends. Additionally, stocks that are hitting a new high often continue to hit those fresh highs. So this axiom is conveying and encourages going after the winners rather than looking for those stocks that are depressed or deeply oversold.

Since you're going after a quality stock at least as deemed by the market and a persistent uptrend, we assume that the company is going to continue to deliver. So the axiom is suggesting buy into strength, ride the trend, and presumably you will have an opportunity to sell at a higher price down the road.

MARK: Nate, before we get kind of too deep in this, maybe it's useful to just pause a bit and have you define what you mean by technicals and what you mean by fundamentals, because that's going to come up again and again going forward. 

NATHAN: Absolutely. Yes. So technical analysis, it's basically the study of price history or charts in order to identify trends, patterns, or indicators, which may help the trader forecast where the price of the stock might be going in order to have a thesis and then basically potentially profit from that analysis.

There are literally hundreds of chart patterns and indicators that can be utilized to analyze price. And I'd say if you're considering trading, I think it's imperative that you at least have a basic understanding of technical analysis, if only because this practice exists, and it's likely going to have some influence on stock price movement. 

Fundamental analysis is the study of a company's intrinsic value. So you're looking at macroeconomic factors or company-specific metrics such as, you know, how much is the company earnings? Are the earnings growing? What's the revenue sales like? What's the sales growth look like? What is the cash flow? Is the growth accelerating or decelerating? Does management have a history of executing or beating analysts' estimates? And all of this ties into the present value of the company based on the future or projected earnings growth.

MARK: So Nate, that takes us to another kind of well-known axiom. You know, obviously very key to technical analysis, and that is the trend is your friend. So can you tell us a little bit about, you know, what's the notion behind that one?

NATHAN: Sure. Absolutely. Yeah. This is probably the core tenet for technical analysis. If trends don't exist, technical analysis doesn't exist.

But why is the trend your friend? So look, I think there's several supportive factors that I believe back the persistence of trends. First, like I mentioned, technicals and fundamentals are not divorced. So meaning if you're looking at a stock in a long-term uptrend, likely that's reflecting the market's perception of its increasing value because it's continually executing on fundamentals.

Next, stocks that are in uptrends likely have the positive reinforcement of the technical community, meaning stocks that are in uptrends, generally, technicians are looking for those trends. They're looking to buy those uptrends and profit from them. That type of buying can help reinforce the trend. 

Conversely, stocks in downtrends have the negative reinforcement of the technical community because they're looking to short the stock on those counter-trend upticks, so that shorting or that selling is creating additional downward pressure on that trend, and it kind of reinforces it.

Next, you have the analyst community. When a stock's in an uptrend, you have these analysts that are coming out and generally going to be upping their price target or upping their ratings as they make these adjustments. They tend to lag in terms of when they come in to the market, but those upgrades or downgrades can influence the price of the stock, obviously.

Conversely, on a downtrend, they're likely going to be downgrading or lowering their price targets. That has negative perception. And then lastly, Mark, I think this is important too. If you can think about the shareholder base of a stock that is in an uptrend, generally speaking, those shareholders are sitting on profits.

They feel confident. They don't feel like they need to sell. If the company is executing, why sell now? And conversely, if you're in a downtrend and you own a stock, you may be watching these losses continue to increase as the stock is in a downtrend. And what's the emotion behind that? Fear. So you have more of a fearful shareholder base, and what does that do? Well, it has a tendency to reinforce the trend, be it up or down. 

MARK: Yeah, I think what you're kind of leading into is, of course, one way to make money is buy something that's going up. Another way is to make sure you're avoiding those things that are going down. And that leads to kind of a variation of the trend is your friend, kind of customized, if you will, for things that are going down, and that's called don't catch a falling knife. So talk to me a little bit about about that one and why that's kind of a special case, if you will, of trend is your friend. 

NATHAN: Sure. And, you know, they call it a falling knife for a reason. And perhaps the danger that could be associated with that. And, you know, if you think about those negative reinforcing factors, when I was speaking of a downtrend, when you have a stock that's in a freefall or in a well-defined downtrend, it's doing so because likely there are those poor fundamentals or execution for management. The technicians that are shorting the counter move, the analysts downgrade, or a more fearful shareholder base that are reinforcing those trends.

So if you believe in trends, if you believe they're going to persist, why would you step in front of a downtrend if you expect that trend to continue? So it's really trying to say, "Hey, don't try to be too brave. I know the stock is falling, and it may look attractive, but if that trend continues, you're setting yourself up for potential losses."

MARK: Yeah, I think that's really hard to do in practice because you see that, like in most things, if you see the price is coming down, it actually becomes more attractive. So it's kind of hard to avoid those things in practice, right?

NATHAN: Yeah, absolutely. We're all human. And for many investors, you know, there's something really tempting about buying something that's on sale or, you know, perhaps you like the idea of buying a stock at a 52-week low because, if you bought at a 52-week low, you're basically getting at a price lower than every other shareholder who bought over the past year.

But if you believe those trends exist, again, persist. Then you know, don't step in front of that downtrend because you're basically saying, "I'm going to buy at the bottom," and that often does not happen. 

MARK: Yep. And I think we've all again heard plenty of people say in sort of the media, if, you know, if it was a good buy at $100 a share, it's even more attractive at $70 a share.

So that's exactly what you're talking about. It's a very powerful, powerful urge. So are there any techniques or tricks of the trade that, you know, maybe listeners can use to help them kind of control their, you know, their trading behavior and kind of resist some of the, some of the emotional factors that that you've been talking about? 

NATHAN: Sure. Well, in regards to, you know, don't catch a falling knife, specifically, if you find it difficult to resist buying this stock because, you know, you feel like it's just too cheap or it's overdone, then I would suggest this. Just at least wait for a trend reversal signal. And if you're looking at technical analysis, there are several patterns out there that can help you identify that potentially a trend change may be underway—could be a doji bottom, it could be an island bottom, it could be a piercing line, it could be a hammer, or it could be something that's event driven.

Let's say that you have a company that you've been watching that has just had several quarters of disappointing results, and the stock just continues to gap down lower, gap down lower. 

And let's say they have a quarterly report where they just put it all out on the table, and they kitchen-sink the quarter, and they say, "We're going to do some restructuring," and the stock moves up. That could be a contrarian indicator in the sense that maybe that downtrend is over. 

Lastly, I'll say you could have something like an analyst downgrade of a stock that has just been in freefall for several quarters. And this analyst finally throws in the towel. The analyst capitulates under this scenario. 

And then guess what—I've seen this many times before—the stock actually moves up because it's as if, you know, the last weak-handed shareholder is sold. The last brave analyst has thrown in the towel. And from a contrarian point of view, that could be a time to consider grabbing one of those falling knives. 

MARK: So another thing that I believe kind of speaks to this kind of managing of risk from the behavioral side is never add to a losing position. Where does that one come from? Do you think it has any merit? 

NATHAN: Yeah, I do. And I can personally attest to that. You know, I think, Mark, nobody really wants to admit they're wrong. And, you know, let's say you buy a stock at $100, and now it's at $80, and you consider selling it. When you hit that sell button, you're basically having to admit you were wrong about your investment thesis.

If you don't sell, there's a chance the stock recovers and gets back to a 100 or above, and then you turn out to be right. But when you begin to rationalize like this, this is how some of your trades can turn into long-term holds. And along the same lines, you might be considering, let's say you bought a stock at 100, now it's 80, and you're thinking, well, maybe I should double down on this losing trade, because if I do so, an equal amount, that would lower my cost basis to $90.

Now my breakeven is 90 instead of a hundred. If I can get this stock back to 90, then I don't have to admit that I'm wrong. So I think it really is that trader's psychology that comes into play, that behavior that I don't want to admit that I'm wrong. And therefore, how do I get out of this with being right? But oftentimes it can exacerbate losses if the stock continues to move lower. 

MARK: All right, Nate, we're almost done here. One final question for you is I've been kind of throwing these kind of, you know, maxims your way. Is there any particular one that that you think is especially interesting or that you especially like that you like to cover?

NATHAN: Yeah. Valuation is what matters in the end. So this is, you know, in the short term you can have whatever type of sentiment that can drive the stock price up or down. You can have rumors, you can have various market environments, which will lift investor sentiment and lift valuation across the board. But at the end of the day, if you're an investor and you're buying a stock, you're a part owner of that company.

So there might be several different reasons to buy a stock, but everyone does so believing that they'll be able to sell at a higher price and make money. Now the value of the stock is based on the company's future revenue growth, future earnings. Also its cash flow, its book value. This is the primary driver of the value of the share of the stock in the long term and what markets ultimately use to determine a fair present value.

So in the near term, there might be those gyrations that will, that will move according to technical analysis or whatever geopolitical event of the day is going on. And, you know, there's going to be that type of speculative activity that occurs. But at the end of the day, you own part of that company. You are basically saying, "I believe in this company. I believe it's undervalued." Or "I believe it's going to grow. And I believe, therefore, my investment is going to grow." Because it is that valuation that is the ultimate determinant in the long run. 

MARK: So I think that was a really interesting answer. And I wonder if you could … I told you that was the last question, but I got one more here. So humor me. In what ways do you think that what you were just describing kind of highlights the … almost the differences between kind of a short-term approach and a long-term approach to investing and how they really differ from one another?

NATHAN: Yeah, good point. I think it's important to understand basically why you're buying that stock. You have some type of a thesis that's in place, whether it's an investment, you believe the stock is undervalued, or it's going to be going up over time, or it's going to be growing over time, and therefore the value of your investment grows over time.

But if it's a trade, then you likely have a thesis that is based on some kind of a setup, a technical event, a catalyst, which also you believe will result in a higher sale price. So the important thing to consider is whatever reason that you are holding to when you get into a trade, if that thesis doesn't manifest, or it turns out to be wrong, you need to cut bait and be willing to say I was wrong, cut your losses, and move on to your next investment. 

And equally important, if you're looking at an investment, you've done your research, your due diligence on a company, and if for whatever reason that company isn't executing, or the fundamentals deteriorate, or something materially changes. You need to be willing to cut bait and manage your investment that way. So the market's about knowing what to buy, but you also need to know when to sell, whether you're an investor or trader.

MARK: Yeah, that is a great place to wrap up. Nate Peterson is a director of derivative analysis at the Schwab Center for Financial Research. Nate, thanks for being here today. 

NATHAN: Thanks so much, Mark. It's been a pleasure.

MARK: Your financial life is important, and I'm pretty sure everyone listening believes that, or they wouldn't be spending their time listening to an episode of a podcast called Financial Decoder.

The problem we all face, though, is that there are many important things going on in our lives. 

And because of that, it's hard to come up with the time to really investigate in detail every decision we need to make on those important things.

As a result, it becomes easy to simply let our decisions be governed by phrases that sound nice and make sense on their surface.

And as Nate demonstrated in our interview, there's a lot to unpack in these common phrases when we try to apply them to our own situations.

It's easy to say, "I know better, and that's good advice for other people, but I know what I'm doing."

Fair enough, but here's the thing about the illusory truth bias.

In a study of the effects of repetition frequency on illusory truth out of Georgia State University,[1] it was found that (and I'm quoting here):

"The largest increase in perceived truth came from encountering a statement for the second time, and beyond this were incrementally smaller increases in perceived truth for each additional repetition."

In other words, hear something twice, and it's already starting to, at least in this study, starting to plant its seed in our brains.

I thought that was interesting, but even more interesting was the fact that, in a different study, it was shown that even when someone knows something else to be true, the illusory truth effect can still mislead them.[2]

Despite that somewhat depressing result, I still think that the best defense against a bias like this is awareness.

But awareness isn't enough. You have to place all the information you gather into context.

As Nate explained, that context can be the overall macroeconomic environment, the previous price action of a company, or details about the company itself. In most cases, it will be a combination of all of the above.

Finally, there's one more saying that holds true above all the rest: 

"Don't believe everything you hear."

Now it's time for the What's New segment.

This is where I give you a snapshot of a recent finding in behavioral finance that just might be relevant to your financial decision-making, or maybe it's just kind a cool study that I wanted to share.

And I think this study checks both of those boxes.

Before I dive into it, it's useful to know that I'm recording this the day after the NFL conference championships. Those games determined that the Kansas City Chiefs will be playing the San Francisco 49ers in the Super Bowl that will be occur about a week after this episode is published.

When I was much younger, frankly, I didn't pay that much attention to football injuries. They happen, they're part of the game, these amazing athletes recover, and life moves on. Now that I'm older, I'm much more attuned to injuries and the pain they cause.

In both games, there were numerous players playing with injuries that had to hurt no matter how much their adrenaline was flowing. Not only that, but how much pain are injured players in even when the games aren't going?

Given all that, I remembered a study that came out last year from a group of German researchers. The study is called "Relating the Visceral Factor of Pain to Domain-Specific Risk Attitudes."[3] That's a mouthful, but fortunately, the results are straightforward.

The authors looked at how pain can affect our willingness to take risks in various realms of our life, including our financial life. Pain in this study referred to survey participants who suffered from pain in their backs, arms, legs, or joints, or from headaches.

Researchers gave them a questionnaire that focused on risk across several areas of life and then did an analysis looking for patterns in the results. The study looked at this relationship using five different methodologies to make sure the results were robust. And they found that only in the financial realm was higher pain consistently associated with lower willingness to take risks. They also found that this relationship held only for participants under the age of 65.

The authors speculated that people in pain worry that they won't be able to work, and as a result, would not get paid. This would, of course, negatively affect their financial situation and cause them to be more conservative.

In the past, we've alluded to the fact that you should be careful when you assess your risk tolerance. There are many factors that influence it in the short term, and one of those factors is being in physical pain. So if you've got a bad back that's temporary in nature, be mindful of that when having a risk-oriented discussion with a financial advisor or making decisions on your own. 

Of course, if chronic pain is an issue, then that may be associated with a more fundamental health condition, and of course your level of health should be something that you think about when planning your financial life.

That's our show, everyone, thank you for listening.

If you'd like to learn more from Nathan Peterson, you can find more of his content for Schwab at the link in the show description. There's also a lot of other trader-related content at Schwab.com/learn.

To hear more from me, you can follow me on my LinkedIn page or X, formerly known as Twitter, at Mark Riepe: M-A-R-K-R-I-E-P-E.

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For important disclosures, see the show notes and Schwab.com/FinancialDecoder.

[1] Hassan, A., Barber, S.J. The effects of repetition frequency on the illusory truth effect. Cogn. Research 6, 38 (2021). https://doi.org/10.1186/s41235-021-00301-5

[2] Fazio LK, Brashier NM, Payne BK, Marsh EJ. Knowledge does not protect against illusory truth. J Exp Psychol Gen. 2015 Oct;144(5):993-1002. doi: 10.1037/xge0000098. Epub 2015 Aug 24. PMID: 26301795.

[3] König, A. N., Linkohr, B., Peters, A., Ladwig, K.-H., Laxy, M., & Schwettmann, L. (2023), "Relating the visceral factor of pain to domain-specific risk attitudes," Journal of Behavioral Decision Making, 36(4), e2323. https://doi.org/10.1002/bdm.2323