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Confirmation bias: I don't like this information i like this one!

November 15, 2017

 

The ability of human begins to convince themselves of what they want to believe
(which might not be the truth) has another tool, Confirmation Bias. This is when
people look for and notice only what confirms their existing beliefs, and to ignore or
undervalue what contradicts it. Selective exposure, perception and retention, in other
words selection bias


We will mention many times how once investors make an investment, they find it
very difficult to change their outlook regarding its prospects once new information
comes in. Or how once a trader makes a trade, they find it difficult to accept their
initial hypothesis is not materializing and cut their losses. They face cognitive
dissonance


Let’s assume you bought shares in ABC Company, because the company is in good
financial health and growth prospects look good. However as time passes situations
develop and fundamentals change, for the good and the bad. A rational investor would
give both the good information and the bad information its proper weight and update
his outlook accordingly. If however we fall into the all common trap of finding it
difficult to accept losses, or not bothered with the effort of not assessing what the new
information means, we might start protecting our original outlook and process
information incorrectly.


New competitors stealing market share, not important! Company CEO says research
and development will come up with new excellent products, you bet it will!  A former
employee mentions how the company is inefficient, what does he know! Other
employees are saying great things! Basically we stop assessing circumstances
objectively and develop screening criteria of which information is allowed to filter
through into our assessment and which receives importance. We become prisoners of
our own assumptions


So how do we deal with this bias?


- Accept the fact that even well informed decisions can result in negative results
- Actively seek information that challenges your existing beliefs
- Be readily to correct previous investment decisions once new assessment
warrants so


That’s the good news, every behavior bias has its remedy.

 

Thanks for reading this quick post, Next up we will look at Representative Bias!

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