Via Prof Sanjay Bakshi:
“Patsy” is defined as someone who is “easily taken advantage of, especially by being cheated or blamed for something.”
“naïvety” is defined as “ a state of having a lack of experience, understanding or sophistication, often in a context where one NEGLECTS PRAGMATISM IN FAVOR OF MORAL IDEALISM”
They means that a naïve man believes that the world is a fair and moral place and he is not being fooled, even when the odds of that happening are monumentally higher than those of the other alternative.
This man is not “PRAGMATIC,” a term that’s defined as someone who “evaluates theories or beliefs in terms of the success of their practical application.” That is, a naïve man is not a practical man who would see the world as it truly is. Such a naïve man is “morally idealistic” who does not assume ulterior motives in others when he deals with others.
Being naïve in life in general may not cause you much harm if you’re lucky. But being naïve in financial markets virtually guarantees significant harm, and even ruin.
You Fooling Yourself
Take for example of what happens when you are invested in something and new evidence comes that ruins your hypothesis. Maybe the business is no longer as good as you thought. Maybe the management is really not as good as you thought or maybe the valuation model was wrong. There could be so many reasons which can ruin any investment hypothesis. The correct thing to do, in such situations, is to recognize the mistake, scramble out of it, and then try not to make that type of mistake again.
Well, the normal outcome, as many of us know, is the opposite. And this happens for reasons we may label as “commitment bias,” “endowment effect,” “psychological denial,” “blind overconfidence” etc etc. We may give this type of tendency all sorts of names, but the reality is that we are really good at fooling ourselves into believing the unbelievable despite contrary evidence.
When we choose to ignore overwhelming evidence showing that we were wrong and continue to stay invested in situations which just don’t make sense anymore, how different are we from that naïve school kid who continued to believe that the coin was fair even after it had landed heads 99 times in a row?
We are not that different at all. And by not being different from that naïve kid, we become a patsy in the game.