How “Confirmation Bias” Hurts Your Investing Decisions & Profits
Learn how to remove your blinders and see the full picture.
In this article, we’ll cover confirmation bias, which can trick even the smartest and most logical investors.
Author’s Note: This article is part of my series on investing psychology:
12 Common Mistakes That Can Destroy Your Investing Profits
Learn how successful investors avoid cognitive traps and build a winning mindset.
Confirmation Bias — What is it?
Confirmation bias is the tendency of investors to search for, interpret, focus on, and remember information in a way that confirms their original point of view.
How does confirmation bias apply to investing?
Sometimes when investors have a strongly-held opinion about a stock, they unconsciously focus their research and interpretation in a way that confirms their viewpoint.
For example, if you’re convinced that a small cap biotech company has a revolutionary new treatment for heart disease, you might Google a few articles that discuss the huge potential for their new treatment.
While this type of research is certainly a good thing to do, confirmation bias has led you to look only for data that supports your original point of view.
This only strengthens your resolve and makes it less likely you’ll seek out information that changes or contradicts your viewpoint.
Two close relatives of confirmation bias are “conservatism bias” and the “anchoring effect.”
Conservatism bias is the tendency for investors to revise their own viewpoint insufficiently when presented with new information that should change their opinion.
Put simply, investors get “stuck” on their original theory.
The anchoring effect is when investors tend to rely (or “anchor”) too heavily on a single piece of information when making a decision.
For example, an investor may buy a stock for $100 per share and even if the business is clearly deteriorating, he continues to hold the stock, believing it’s worth $100.
He has anchored his valuation to his original purchase price, putting too much faith in that number and not paying enough attention to the changing fundamentals.
General Electric’s nearly -80% decline is another good example.
Many investors probably held onto GE as it tumbled lower and lower, thinking to themselves, “This is nonsense. This is GE! A long-time pillar of American industry!”
Sadly, not anymore.
What should you do instead?
In the small cap biotech example above, you could battle confirmation bias by actively seeking out information that could disprove your viewpoint.
For example, maybe you look for articles that discuss how their new heart disease treatment isn’t really revolutionary.
Or maybe you research close competitors to see if they also have similar treatments coming to market. And maybe you also research how long the timeline is for their treatment to go from the lab to the market.
Maybe your original theory is correct and you still buy the stock. That’s great!
The point is, you should seek out complete information so you can make the best choice possible.
- “Have I sought out a range of objective information that could both support and contradict my theory about this stock?”
- “Have I adequately adjusted my point of view based on complete information and weighed it all fairly in my trading decision?”
If you can answer, “Yes” to both of these questions, you’ll be a long way towards making smart (and profitable) investment decisions.
Disclaimer: This article is provided for informational or educational purposes only and is not any form of individualized advice. All information is obtained from sources believed to be reliable but cannot be guaranteed for accuracy or completeness. Use this information at your own risk.