Investing Psychology: Confirmation Bias
“People only listen what they like to listen” is a generic statement which has deep-rooted psychological meanings.
If you consider psychology and investment, both go hand in hand. Since the two are closely related, you would know that one changes (or alters) the effects of the other. One such psychological phenomenon is known as “Confirmation Bias”.
Let’s put this phenomenon forth with an example:
While purchasing a phone online, do you take the efforts to check for its reviews online? If yes, congratulations, you are an intelligent buyer.
However, the point is something different. Suppose that you really wanted to buy this phone for a very long time and have finally managed to have the savings to purchase it. Now, when you are reading the reviews, you would actually consider every positive review about the phone but will mentally decline the negative ones. Sounds familiar?
This concept is related to “Confirmation Bias”. Now, this was a basic idea just to give a glimpse of how this works to our readers. As we will proceed with this article, we will discuss a bit more about the confirmation bias and how it can affect your investment decision.
Human Mind and Biases:
As complex as our human mind is, scientists have been able to infer different phenomena related to the subconscious human mind. The confirmation bias is a result of one such phenomenon. Before moving further, let us discuss – what does the term bias mean?
When a human mind is determined towards one particular behavior, it subconsciously rejects the pieces of evidence against it while confirming the ones that go in its favor.
While we as human beings are found doing this all the time, these actions can be pretty dangerous while making an investment.
Investment and the Confirmation Bias:
Psychologically speaking, an investor would be more inclined towards his pre-occupied information and knowledge about certain kinds of investing. While considering the pros and cons of a certain kind of investment, the buyer would most likely go with what he used to believe until now.
For example: Making an investment in Bitcoin is dangerous and pointless.
If this is an investor’s pre-occupied notion then he would most likely not invest in bitcoins in future. Moreover, the information that will be fed to the investor in favor of this notion would be acceptable to him. On the other hand, the information that would oppose this notion would be rejected by the investor.
Most obviously, this particular bias is not only limited to investment but prevails in almost each and every domain. If you notice closely, the confirmation bias restricts you to consider only one point of view and pushes you to almost reject the others which are lethal to decision making in investment. In fact, in order to make good investment decisions, one needs to consider a scenario multi-dimensionally.
If one fails to do so, he can make wrong investment decisions possibly incurring heavy losses in future.
Confirmation Bias in the Stock Market:
There are various scenarios in the stock market where you can find confirmation bias influencing the investment decision of an investor. Here are few examples:
- When an investor finds a ‘hot’ stock in any financial website/magazine, he/she will research it further only to prove that the supposed ‘potential’ is real. They might look at plenty of positive news regarding that stock. In the same time, they’ll ignore the red signs, just by making excuses like ‘It’s not going to affect the company much’.
- If the stock price of a company starts falling, the investors start looking at all the negative flags only. Even if the setbacks are temporary and the company might have a good long-term future potential, however here the investors are more biased to the negative flags and totally ignore the positive factors concerning that stock.
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How to Avoid Confirmation Bias?
The easiest approach to avoid confirmation bias while investing it to take an expert advice from a trained financial advisor.
Don’t we always take a second opinion from our friends or colleagues for every little thing we do? Be it selecting an outfit for an important event to taking major life decisions, a second opinion actually helps in backing up our decision. Therefore, you would want your second opinion to be totally unbiased and reasonable, wouldn’t you? That’s what expert advice is for.
Make sure that you ask for an advice from an experienced investor or from an expert financer. An expert advice makes you see the alternatives in a better way.
Nevertheless, with practice and experience, even an individual investor can avoid confirmation bias, without even taking help of an advisor. Here are two important steps that you need to contemplate in order to avoid confirmation bias.
1. Look at each and every dimension: Considering only pros or only cons about an investment would make the information partial (incomplete). Hence you need to view a scenario from different angles in order to make a backed-up decision.
2. Take some time before you pop a decision: Time is an important factor and it actually helps in unfolding various new information with it. An intelligent investor knows the amount of time he needs before he could finalize his decision.
Confirmation bias is not new to the investing world and do not regret if you have been following this psychology even without knowing. However, now that you understand that confirmation bias can adversely affect your investment decisions, you need to avoid it.
Although confirmation bias is a human instinct- nevertheless, you can control/avoid it with practice and experience.