Avoid the “Negativity Bias”

It has been a painful couple of weeks for stock market investors.

At times like these, we take a step back and look at the situation with some perspective.

Today, we share one of my favorite essays on a critical concept to remember when investing in this kind of volatility.

Whether you're a longtime reader or new to HX Research, this is a good reminder of something hardwired in our brains that we must overcome...

One of the biggest arguments in all of investing is whether the markets are "efficient" or not.

The idea of an "efficient market" is that all the available information is "priced in" to stock prices. This means that investors have no natural way to gain an advantage.

But instinctively, we know this is not true. All you need to do is watch a stock drop 5% on an analyst downgrade or a tweet from the CEO, and the logic that this is all priced in doesn't stand up.

The primary reason why markets are not efficient is because, ultimately, human beings make the vast majority of investment decisions.

As much as we would like to say that these decision-makers are rational and unemotional, hundreds of thousands of years of genetic programming still govern our actions. These responses were developed to keep the human race alive—and they worked! It's hard to override that with a couple of years of business school.

The most powerful of these responses, which impact trading, is called the "negativity bias." This is a condition in which adverse events impact our brains more than positive ones.

Research on human brain activity has shown that negative stimuli generate three to 12 times more physical (electrical) responses than positive stimuli.

One famous experiment by economist and psychologist Daniel Kahneman had participants imagine losing or gaining $50. Even though the amount was the same, the emotional response of those losing the money was more significant. The negativity felt around losing something is much larger than the advantage of gaining something – even if it's the same amount at stake.

This makes sense... For ancient humans, a good meal from a fresh kill would trigger a positive response and a full stomach, but falling off a cliff would trigger death and no more responses.

Earlier in human history, paying attention to negative stimuli was a matter of life and death. But today, it gets in the way of good investing...

One of the most common issues is overemphasizing the "negative" factor and missing out on great opportunities.

My favorite example of this is not buying a world-class business because of the valuation or some recent short-term disappointment.

In fact, our portfolio at our trading publications—HX Trader and HX Income—is full of these kinds of opportunities. We look for great businesses with long histories of operational success and great stock price performance that have stumbled because of something immaterial to the business's value.

Investors that have sold these stocks have overemphasized the negative. In many positions, we see companies that have beaten expectations on every metric but one, and the stocks tumble.

This is a prime example of negativity bias.

Another problem is when we dwell on adverse events... even after they have passed.

I've fallen prey to this even in my investing, where I would have a portfolio of 30 stocks but spend 90% of my focus on the one or two losers in that group.

Those stocks ended up being doubly dangerous because they not only lost me money but also prevented me from properly focusing on the rest of the portfolio. This resulted in missed opportunities and—equally important—made me miserable.

Don't discount the psychological impact that "losers" can have on your investing beyond just the money you've lost.

Are you wondering what is going on with $TLN and the other IPPs $CEG $VST?

We did a 30-minute interview yesterday with James Early, CIO of BBAE Pro going through the thesis and current situation. Watch it on YouTube.

HX Research founder Enrique Abeyta says that Talen Energy (Nasdaq: TLN) is his top stock. Talen has almost doubled since Enrique first pegged it for his readers, but he thinks it has room to run, based on several specific criteria:

1. AI-driven power demand from data centers

2. Power demand from electric vehicles

3. The reindustrialization of America

4. A baseline of slow, steady power demand growth from population increase

5. A coming power crisis arising from too much demand growth against too little supply growth

Talen, which has cleaned up following bankruptcy years ago, has prime nuclear generation assets that would be next-to-impossible to build today. That's one reason why Enrique thinks Talen may be buyout bait for a larger utility or even a tech company. Hear more -- and why Enrique thinks independent power producers (IPPs) are trading too cheaply -- in our video.