Do you feel good when you meet others who share the same opinion and do you love to avoid criticism?
We all believe that our opinions and viewpoints are correct and cannot consider other’s opposing views. We dismiss the other person as ignorant or stupid. We try to reject the evidence against our beliefs, and we look for news and information that reinforces our opinions.
This selection of opinions and information that strengthens our pre-existing notions and refusal to acknowledge and accept other views is known as ‘Confirmation Bias’.
And we can blame evolution for this bias. We evolved to process the information on an automatic framework. Our brain takes shortcuts so we can focus on what we think is the most important things.
Daniel Kahneman’s in his book Thinking Fast and Slow, calls it System One and System Two.
Jonathan Haidt’s The Righteous Mind provides a metaphor for the rider and the elephant. The rider is the conscious mind in charge of rational and strategic thinking, while the elephant is everything else. Everyone can easily imagine that the elephant can overpower the rider.
Confirmation Bias on investment
We can also see the effects of confirmation bias in the world of finance and investing. If you are an investor, acknowledging confirmation bias in your decision-making capacity and making rational investment moves are significant moves.
In equity investments, many equity market participants aim to time the market. Some believe that the markets will go up, while others fear the opposite. Under normal circumstances, if you think that the market is going up, you will support the case of market raising. You will find the green flags to support your prediction everywhere, from newspapers, finance news shows and your closest buddies. However, during this time, you will conveniently ignore the red flags. This is nothing but confirmation bias in action.
Another way through which confirmation bias affects your investments has to do with your choice of questions. Investors ask questions that will provide an affirmative answer that will go with their beliefs. The problem with these questions is that one can answer these questions with supporting data rather than data that considers all the different aspects.
How can investors fight confirmation bias?
Acknowledging that we don’t always make rational investment decisions and are prone to behavioural biases, such as confirmation bias, is the first step towards fighting confirmation bias.
Here are a few ways that can help you fight confirmation bias:
Look for ideas that make you uncomfortable and evidence that contradicts or conflicts with your existing investment philosophy. Make your investment decision only after you have considered both sides of the decision.
Every financial transaction has two sides. If you are buying a company’s stock, that means that someone is selling. Try to figure out the rationale behind the other investor’s decision. Are you overlooking something, or do they have access to some other information?
Ask other friends in your investment circle to persuade you not to take the investment call. Take their help to challenge your findings. As they come up with reasons that contradict your call, you will be more likely to make a rational decision.
Investors are humans, and not taking behavioural bias into account is one of the significant factors behind investment mistakes. Confirmation Bias is one such behavioural bias where investors seek information that confirms their investment decisions and turns a blind eye to contrary information. So, consider all the aspects involved before taking an investment call.