Don't Be A Victim of Confirmation Bias...
Imagine the following story:
You get a Fitbit for Christmas and you love it. What a fantastic gadget. It tells you how many steps you took for the day, how many calories you burned, how many hours of sleep you got and how close you are to reaching your health and fitness goals. How could you live without it?
You find out that three of your friends have one, as well as numerous people you work with. They’re everywhere. A great product like this must be a great investment?
After a few seconds on google you find out that the company is publicly traded and you can buy the stock. There are a few negative news stories about the company but you end up finding positive reports, analyst buy ratings and good looking charts. All of this confirms that your idea to invest is a good one. Not only are you improving your health and fitness but you also hope to improve your bank account. You buy the stock.
A few months pass and stock is down 10%, 15% and now over 50% from where you bought it. Negative news stories about the value of the stock and the future of the company are everywhere.
However, after a little bit of digging you still find a couple positive analyst reports, a new product launch that will take place next week and the product seems to be more popular than ever.
This is more than enough information to let you know that hanging on to your investment is the right thing to do. A few weeks later you now realize that your shares are down over 80 percent!
This is the danger of confirmation bias. It happens all the time without us knowing and can cause account destroying losses.
Confirmation bias is the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. It helps to explain why people tend to seek out information that confirms these beliefs and opinions. Even when reliable and legitimate information is presented that’s counter to those beliefs, most will overlook or dismiss that information as being irrelevant.
In most instances, we carefully gather and evaluate facts and data before coming to a conclusion but in actuality we come to a conclusion first (I want to buy Fitbit stock). Then, we gather facts and see those facts as actual support for our pre-conceived conclusions (Fitbit is a great piece of technology. It's very popular. Lots of people I know have them).
Here are some simple ways to avoid being a victim of confirmation bias:
- Acknowledge that confirmation bias exists and that your judgement can be clouded by it.
- Have a clear and concise plan before you enter a position. Make sure you're making decisions based on facts and thorough analysis.
- Remove your ego and emotions from your investment making decisions.
- Seek out and understand arguments that disagree with your belief.