Decision Making and its traps

Decision under risk and uncertainty

Wise decision making supposes to do choices that are consistent
with both the realities and our goals.
It supposes also that our goals are non destructive.

It is normally a several step process
from identification to evaluation, choice and implementation.

Pitfalls and cognitive and emotional biases might intervene at each step.
Whence the need to know what happens in the brain when we make
a decision, and whenever possible to follow some logical method.


When our brain  rational and emotional
neurons
compete for championship in the
ring of
diceuncertainty.

Definition

Decision-making, as a process, is to decision choose between several
possible courses of actions
in order to tackle an issue (whether a
problem or an opportunity) and/or to fulfill an intention.

And flipping a coin is not often the best solution, if only because it can
fall into the sewer. Well, permanent indecision is not better.


To bring effective outcomes, decision-making supposes a sufficient degree
of
rationality, a notion that can be defined as how consistent is
the choice
made according to:

* The realities of the situation,

* T
he decider's goals

   (within the limit that those goals are wise and non-destructive)

The  two breasts (*) that feed decision are:

* cognition (observation, memory, reasoning)

* and emotion


=> Rationality is obtained by using the right dose
of each milk source.

(*) Sometimes those two conscious feeders are bypassed by  a
      third one, less conscious : automatisms (habits, reflexes,
      compulsions...).

      Such unconscious or semi-conscious choices can hardly
      be called decisions

What also play a part are
heuristics.
They are
shallow analyses, on the basis of simple - immediate or
sticky - impressions or representations.

They are  at the border between reasoning and emotional biases on
one side and routine cooking recipes or automatisms on the other.


Ethics also intervene, but it can do it at various levels : cognitive,
emotional or reflexive / heuristic
To sum it up as our friend Confusioux says:
"Decide with your head, your heart, your guts, your feet.
Or just ask your spouse."

The decision process, step by step

Ideally, an elaborate artwork

The decision-making process - and its cousin the problem-
solving process -
are often filled with complications, traps and pitfalls.

Whence the need:
  • To know what usually drives us,
thus what happens in our brain, when we decide.
This article gives some (precious) hints about this.
  • And to follow some logical method.
As seen below, an effective decision process includes normally,
several
gradual steps.

Of course some choices can be done instantly
, when the
opportunity or
danger strikes, or when we are fully prepared.

=> There is then a direct / unconscious mental path between perception
     
and action.

Most usual decisions can be left to unconscious reflexes and routines,
but
crucial choices on new situations need an elaborate step by
step method
...if time allows.


But what about intuition?

Intuition supposes
a lot of experience before, and a strong
idea of what we
pursue. 
It usually comes after having
fully explored the issue but
without
finding the "mental opener", the sudden idea that
helps put the pieces together.


Actually many decisions, actions, and also many conscious
thoughts, result from
crossing and assembling complex data
done by our neurons
"in the background" more than
through conscious reasoning.


Another thing, never confuse intuition and emotional
impulse. Thus, keep cool !
As seen below, using an antistress method, and also waiting
overnight to decide or
to apply a decision can help muster
this unconscious power of intuition.

Two warnings anyway!

* Reflexes and habits can bring routines.
   From time to time it is good to ree
valuate our usual practices and
    to check if they still fit
situations, if only because the world is changing.
   => Better don't wait that an external or
internal shock make them
         obsolete without warning !


* To rely on instant instinct or intuition can trigger brilliant moves.
   But do 
not expect always a free lunch from them, careful about your
   stomach
!


Some researches have shown that experts tend to be overconfident
about
their experience and to make blunders in some new situations.

A. Identification steps

Investigating what it is about, Dr Watson!

1) Gathering information, as complete as possible,

2) Recalling knowledge and prior experiences,

3) Understanding the various sides of the issue
     and making a diagnostic

B. Creation and evaluation steps

Preparing the choices wisely, Mr Confucius!

4)
Imagining the various possibilities of actions,
Here, enlarge your imagination, think differently, creativity
can be learned, practice creativity techniques.

Also do not discard "intuitions", as seen above.
But separate those that bring
solutions that match a diagnostic from
those coming from to
pure emotion, mind conditioning or illusion.
5) distortasymm Comparing, weighing and evaluating them
Here, various criteria, goals and values are needed.
Also adequate methods, related to the domains at stake, are
useful (for example, in two specific areas, the SWOT analysis
and the asset valuation method)

C. Action steps

Raising the anchor, Admiral!

6)
Making a choice between those alternative solutions / actions

6b)
If the course of actions is complex, preparing a planning.


7)
Implementing the decision (if there is no action, there was no
     decision ...unless we made the conscious choice not to act)

D. A rerun might also be helpful

Play it again, Sam!

Of course, such an ideal process needs a lot of means, efforts or time, all
the more if the goal is to optimize the outcome to the last penny.

Also some iteration is useful.
In other words better "think twice" before implementing a decision.
We should not neglect, whenever possible, to "sleep over it" or to use an
antistress trick.
This long process should not mean
indecision and procrastination
(delaying tactic, status quo bias...),
all the more in an emergency.
There are even times when decisions, even crucial ones,
have to be taken instantly, under instinct
.


But having thought before at several
éventail scenarios might
precisely help to see things clearly in such an emergency.
Of course, we might also consciously decide that the best option is
...to do nothing.

E. What about advisers?

Going to the seers?

In some of those steps we might need the help of professional experts.
It is OK, and more than OK in highly technical fields, to get the right and
full information, but only if we avoid
to be too dependent on them and
thus lose
our own freedom of investigation and decision.

The decider should always be the decider.
It should not tell later, if things went wrong, "that was fully the expert's
mistake, I am not in the the least responsible to have blindly followed it
".

What happens in the brain brain?

Which neurons, and brain secretions, will win the battle?

A. Brain activators and moderators

Neurosciences help to study what is at play in human beings when they
make decisions. This field of research examines chiefly, luckily without
opening people's skulls,

ˇ What brain areas, electric waves and chemical secretions,
  notably neuro-transmitters that jump between neurons,
play a
  part in the decision process,

ˇ
What stimuli have an influence on those areas and connexions,

ˇ
And also what other parts of the brain try to resist to such stimuli.
  S
ome "moderator" neurons (and chemical secretions) act as an
  inside brain police, a simplified explanation of course of something
  much more complex.

B. Emotional vs. logical thinking

Those researches have shown that in many circumstances emotions
(hope, fear and many others) override logic
in decision making,
as emotions are what motivates people to act.

ˇ With only thoughts, and without emotions, people would
  spurn actions
, they would lack the "guts" to take risky decisions,
  and thus limit their behavior to routine maintenance

ˇ
On the other hand, when emotions kill reasoning, the
  probability of mistakes and even disasters becomes quite high.

Another thing is an aversion to decide because of the effort to dig
further than
superficial aspects (and thus be happy with superficial /
simplified reasoning: see
heuristic) and also the mental pain to
make a choice

C. Logical flaws and "wired" reactions

Emotions are not the only potential source of maladapted decisions, as
also:

* Cognition (perception, memory, reasoning) can be affected by various
   mental / behavioral biases. and heuristics

* Some neuron connections get solidified / wired due to habits
   (automaticities), therefore hard to change when those habits are
   or become harmful.

Decision making in economics and finance

sous Nothing like money into the slot of the human thinking
           machine to activate its gears.


Among all human activities in which decision-making is crucial, those
related to money make a large subset.

A typical example is investing in asset markets.
Obviously some precautions for investors are needed.

A. Financial risk taking

To buy or sell a financial asset belongs to

"decisions under risk and uncertainty"

This has been qualified as such
,

  • By probability theoreticians interested in finance.
Thanks to them, dice calcul probability calculations (aka
"stochastics") are at the basis of most standard financial decision
models,
  • As well as by behavioral finance theoreticians,
such as Daniel Kahneman, who distance themselves from those
idealized rational models.

B. Are the risk criteria always rational?

People are supposed to ask for a higher return from risky investment than
from those considered riskless (
risk premium).
But this is not so simple as, when facing risk and uncertainty people
are highly prone to behavioral biases :
* cognitive biases,
* emotional biases
* and inappropriate automaticities.
 
They lead to wrong appreciations of risk, decision errors and
misreactions.

Thus, their decisions might not match exactly their utility,
although that notion (*) is one of the bases of economic theory,

(*) a far from simple notion, as many
utility paradoxes has been
found by researchers)
Our glossary (see below) cites many of those biases and errors.

In extreme cases, money can make people do
sillymad crazy things or, on the
contrary,
temperature  freeze their thoughts and paralyze their behavior.
Well, not only money can do that, but we are not talking here about all
human fantasies.

C. The importance of the plancalend time horizon

Financial decision making has to take into account the investor's goals,
themselves linked to its time horizon.
In this respect, there is a difference between short term trading and long
term investing: see passive or active investing.

D. Are computers better at financial decision making?

Robots playing with money.

Those human limitations have lead to use computer models to replace -
or at least assist - human decisions in many fields, among them economics
and finance.

This does not mean than computer-aided decision software, using their so-
called "artificial intelligence" can always do better,
except in some
clearly defined recurrent cases
.

The robot  robotic models that are currently in use and are fed by "big data"
are progressing, but they still cannot encompass all factors
(see traps and limitations of economic models and projections).
They are stuck in the past and the present so cannot fully imagine future
possibilities.

They are at a loss when facing rare, or completely new, situations in which
probabilities are unknown
and in which scenarios have not been
foreseen
thus not entered as parameters.

A similar trap is an overreliance on
statistics and other numerical
data.

Here, a balance has to be found :
* Those tools are quite useful, to ignore
probabilities often backfire into
   illusory decisions.
* But if intelligence and direct investigation are shunted by numbers,
   some of them could also prove dramatically irrelevant or misleading
   (see probability)

Source and further readings

More details can be found in the extensive
Behavioral finance glossary

  visits (sample / échantillon)

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M.a.j. / updated : 09 Aug. 2015
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