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About Confirmation Bias in the Stock Market ( HEMANT )
| From : Hemant Parikh at 11:56 PM - Mar 11, 2010 (23 months ago) |
About Confirmation Bias in the Stock Market
What is confirmation bias? It is a cognitive bias that makes us look for information that confirms our theory or belief while ignoring anything that contradicts such belief.
This is an area of behavioural science that is of particular importance in the field of research science; such a bias should not cloud critical thinking when doing experiments.
Scientific research papers go through a process of vetting at different levels by guides, peers, publishers before seeing the light of day. Any cognitive bias involved in the design or measurement of experiments are quickly detected.
A similar process is sadly lacking in the field of stock research. The other day, four research reports about a particular company landed in my inbox. Two of them recommended a 'buy'. One a 'hold' and another, a 'sell'. All four reports had pages of charts, figures and convincing arguments to back their respective recommendations.
The interesting thing to note is that only one out of the four gave a 'sell' recommendation. Why interesting? Because a 'buy' or a 'hold' call is much easier for the human mind to accept. It confirms that we were 'right' in choosing the stock.
A 'sell' call has negative connotations. It means admitting that we made a 'wrong' decision. It lowers our self-esteem in our own eyes. How could we have been so stupid? Why didn't we see through this crooked management or poor financials earlier?
Confirmation bias is a regular occurrence at some of the investment groups. Some one with credibility recommends a stock as a 'value buy'. Others join the bandwagon blindly. If any one voices a contrary opinion, research reports giving 'buy' calls start flying around. The logic is: 'Who cares about fundamentals? See how the stock is moving up!' Works fine in a bull market. The bear market is already history, isn't it?
Investors must develop critical thinking skills to overcome confirmation bias. Before choosing a stock, proper fundamental analysis should be undertaken. That includes writing down reasons for buying as well as reasons for not buying. Give points for each decision in an unbiased manner. Then decide which side the scales are tilting.
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nice post.Investors must develop critical thinking skills to overcome confirmation bias. Before choosing a stock, proper fundamental analysis should be undertaken. That includes writing down reasons for buying as well as reasons for not buying. Give points for each decision in an unbiased manner. Then decide which side the scales are tilting. A REAL GOOD ONE.ALL HAVE TO FOLLOW.KEEP GUIDING.
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