Investors can have all sort of biases that can prove detrimental to their investment choices and
behavior. By bringing to identify yourself and taking mitigating actions you can avoid these
pitfalls. Remember prevention is always better than curing.
In previous posts we covered confirmation, conservation, representative and anchoring bias.
Biases in how we think, Now we look at more dangerous biases, ones that that boost our ego,
illusion of control and hindsight bias.
Financial Markets can be unpredictable, there are so many variables even the most informed
investors can’t keep up with how all interact all the time, if you think each time you invest you
have 90% probability of success, you may be suffering from illusion of control. This happens
when people think they have control over outcomes, when infact they cannot. Some factors
such as corporate performance and economic conditions represent uncertainty that the
investor cannot control.
The problem with this bias is it can cause you to trade more than is prudent, as you
overestimate the number of successful investment decisions you will achieve. It may also cause
you to take excessive risk, usual the size of the position you take is dependent on how
confident you are in your analysis, if you are overconfident, you will over expose. This can also
result in under diversified portfolios as you eggs in the one basket you are so sure off
Helping you overcome this bias is to recognize the uncertainty inherent in every investment
decision, adjusting your probability of success accordingly. Second keep records of the rationale behind your trades to help self evaluation of past decisions, this will help you appreciate past mistakes more.
Only after things have already happened do we assume to see how easily it would have to
predict it, that’s hindsight bias, when infact at the time it wasn’t all that clear. Everybody now
talks about how the financial crises of 2008 was inevitability, yet very few people saw it coming
at the time. This bias also happens when people think their predictions were more accurate
than they actually are biased by after the fact perspective, they reconstruct memories.
Hindsight bias by overestimating the correctness of you initial prediction can lead to
overconfidence bias, which again can lead to excessive trading and risky exposures. It can also
bias comparisons and evaluations, for example if you are looking for an investment manager or
fund to invest in, you should compare their performances with the information available at the
time, not after the fact, as its not reasonable to assume the investment manager should have
seen it coming when back then it was an uncertainty.
So in conclusion, don’t overestimate you ability before the fact or after the fact!