We all rely on intuition to some extent. In our private lives, we don't question it, but in the investment context, it is often frowned upon as somehow irrational and unprofessional. Hard facts are what investment is all about, right?
In fact, one's inner voice, which makes itself heard in so many decision-making processes, is an extremely valuable resource. Particularly in complex investment situations, it is simply impossible to take all factors into account through conventional managerial and analytical processes. Information may be missing or data may be contradictory, or even just plain wrong. In such situations, intuition and a "gut feel" can play an indispensable role.
Intuition Is an Established Field
Intuition is, in fact, a well-established management subdiscipline and there are experts in Europe and America who specialize in the area. However, in the field of investment, it is very much underrated as a factor in decision making. Yet, most people make use of it to some extent, or at least they should do so.
So What Can Intuition Tell Us About Investing?
Even in relatively straightforward situations, such as deciding what to order in a restaurant - a very small investment - a mere description of the dish is not always reliable. Frequently, a degree of intuition is necessary in deciding what to choose. All the more so in the extremely awkward and often troubled world of investment, figuring out whether a particular fund or stock should go into your portfolio, how it will develop over time and whether problems are likely to arise, is a major challenge.
Given that so many different factors impinge on investment processes and the markets in which they operate, it is somewhere between difficult and impossible to figure out all the angles. That does not mean that all those quantitative techniques do not work, but it implies that in some instances, intuition may work just as well, or even better. Alternatively, a combination of both may be optimal. (To learn more, see Understanding Investor Behavior.)
Intuition can also be useful with respect to timing, which tends to depend not only on measurable factors, but on a variety of issues that are difficult to quantify. We all know that one cannot time the market accurately, but a general idea of how high or low it is can come just as much from intuition as various ratios and indicators.
What Exactly Is Intuition?
The classic "gut feeling" has a very real physiological basis. The digestive tract contains 100 million nerve cells - more than the spine. This part of the body sends an enormous number of signals to the brain, which may contain important messages, but which are sensed initially by the body rather than the mind.
It is inherent in the nature of intuition that it can't be defined precisely - it's a bundle of uncertain competencies and knowledge of various kinds. But it can be divided into three main types.
Firstly, intuition is simply a feeling, a kind of inner "autopilot." One is in control of one's actions, but there is no deliberate decision-making process. This occurs, for example, when a driver brakes, accelerates, changes gear, etc, without thinking about it. Psychologically speaking, this is tacit or implicit knowledge. You may simply think that a certain fund or stock is just not a good bet, and you may be right!
Secondly, intuition can take the form of what is best termed a "brainwave." Sometimes, without even consciously thinking about a problem, the solution is suddenly there in one's mind. For instance, after pondering over Fund A versus Fund B, you may suddenly realize that the latter is the one for you. Only time will tell how reliable your instincts were. (Read more in Taking A Chance On Behavioral Finance.)
Thirdly, people sometimes have an impulse that they should or shouldn't do something. Negative signs may come from a lump in the throat or a peculiar feeling in one's stomach that a strategy is ill-advised, that someone cannot be trusted or a certain investment should be avoided. You may well be right to feel uneasy about a certain person or asset. Conversely, one may feel very enthusiastic about a certain investment, without really knowing why. These feelings are not merely coincidental, they reflect intuition. It may be that you do not trust a certain broker intuitively, even though he or she has not really done anything wrong (yet).
Using Intuition Deliberately
In America, research indicates that managers have been using their intuition quite consciously for some time. So why not brokers and investors?
The ability to use intuition can be learned. Part of the trick is to become more conscious of your instinctive judgment and how it operates. It's worth considering the last time your intuition really guided you, for better or for worse. By monitoring how one's intuition works over time, and in particular noting and analyzing when it has paid off, it is possible to develop and use the process productively. If you find that your own intuitive judgment serves you better than fancy econometric forecasts, go with your mental flow.
This does not mean that intuition should replace more conventional, rational processes. None other than American management guru Warren Bennis commented that the trick is to find the right balance between intuition and quantification, between hard and soft skills. Indeed, given that investments are a combination of money, market and people-oriented things, you can draw on all possible resources. (Read Trading Psychology: Consensus Indicators for more.)
It is also important not to confuse intuition with prejudices and pure emotions. Not every first impression or spontaneous impulse should be interpreted as intuition, and even less so as productive and useful. And nowhere are unadulterated greed and fear more dangerous than the stock market or real estate.
The Bottom Line
In summary, rationality and facts are vital to the investment process and always will be. Nonetheless, the equally fundamental guiding role of intuition should not be underestimated. Intuition provides orientation in uncertain and unknown areas, especially where there is a high level of complexity. And this is precisely what investments tend to be all about.
Furthermore, through active training and a conscious use of this blend of physical and mental capability, one's inbuilt autopilot can help us master otherwise excessively sophisticated and challenging investment processes and decisions. (For more, see Gauging Major Turns With Psychology.)
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