Do you think like an investor, or like a gambler?

Investing involves decision-making. Unfortunately, humans are prone to all sorts of decision-making errors. There are good reasons why this is the case. For example, there are many situations in life where, if you were to allocate the necessary time to make the "best" decision, you would miss an opportunity or perhaps even come to harm.

There are other situations, though, where being aware of the limitations and flaws in human reasoning can be enormously helpful. Investing is one such situation. Countless investors have sustained considerable losses as a result of their human brains.

If you're interested to test out your own reasoning skills, please try the quiz below!

You might also be interested to read an article we have written on the topic of human reasoning: Humans: not optimised for logic

DISCLAIMER!

A number of questions in this quiz will be technical questions involving probability or mathematics. Please understand, though, the purpose of this quiz is not to test mathematical ability! I know of no evidence that success as an investor is correlated with ability to answer such questions.

So why are such questions included? It is because the problems included have objective, defined answers that are not always what seems like the obvious correct answer. The aim of this quiz is not to see how many you can get right – it is for you to explore the way that you think about, and resolve, unknowns - and to learn something useful about the limits of human reasoning and how it can be influenced by emotions.

1.

You are buying a lottery ticket. Bearing in mind that lottery winners are shared if there are multiple winners, what strategy is best for choosing your lottery numbers?

2.

You are with a friend at a legal casino. Your friend is betting on red/black on the roulette wheel. Your friend has just lost money betting red five times in a row with the winning number having been black every time. Your friend asks you if you think he should bet red again, or switch to black. Does either choice give him a better chance of winning on the next spin?

3.

You are researching two stocks (Stock A and Stock B) in the same industry. They both have very similar cash-flows, assets and cash positions in their quarterly and annual reports. Their charts show very similar share price movements and volume over the past 12 months. However, Stock A has a current share price of $1.12, Stock B has a current share price of $15.20. Based on this information, do you think it is:

4.

You work at an investment company. About six months ago you carefully researched Big Gun Holdings and bought significant investments in it for your company after it showed exceptional promise. Now, you have just received an email from your boss with a link to a news article reporting that a whistleblower at Big Gun Holdings has accused the company of intentionally falsifying their financial records for the last three years. The CEO, someone you have great respect for, has strongly denied the claims. What is the first thing you plan to do?

5.

A friend, who always tells the truth, outlines the rules of a betting game: She will flip two coins, then look at the result without you seeing. If any of the coins are heads, she will say “there are heads”. To win, you need to correctly guess if any of the coins landed on tails. On the first round, your friend flips both coins, looks at them and says, “There are heads.” What are the odds that one of the coins is tails?

6.

The correct answer to the previous question was 2/3.


If you hadn't been given any information, the chance of at least one tails out of two flips is 3/4. The only way there would not be tails is if two heads were flipped – which most people know has only a 1/4 chance.


But you know what one coin was. This causes many people to just think about just the other coin, and reason it has a 50/50 chance of being heads or tails.


However, this reasoning ignores an important aspect of the probabilities involved: There are two ways that one heads and one tails can be flipped: heads first then tails, or tails first then heads. However, there is only one way to flip two heads – heads on the first flip, and heads on the second. Given at least one of the coins is heads, it is twice as likely for that scenario to have arisen where one of the coins is tails than where neither of them is.


If your friend had said she would only look at one coin and tell you if that coin was heads, then there would be only a 50/50 chance that the second coin is tails.


Does the explanation of the last question leave you unconvinced or unhappy?

7.

Please examine the two charts below:


Chart A


Chart B


Based only on the movements of prices on the charts prior to November 14, would you be more inclined to invest on November 14 on the stock represented in Chart A or Chart B? 

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About Paul McQueen

Dr Paul McQueen is a Clinical Psychologist, holding a Doctorate in Clinical Psychology from the University of Melbourne. He has experience working in both adult and child mental health services in Queensland and Victoria. Dr McQueen is comitted to providing high quality, evidence-based interventions for a range of mental health conditions. He specialises in the treatment of Obsessive Compulsive Disorder, Borderline Personality Disorder and Depression.

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