12 Cognitive Biases That Endanger Investors
What you don't know can impact performance.
Most of us are creatures of habit in our own way; we use the same toothpaste or align with a particular smartphone device. That routine often extends to our investments in the marketplace; we’re comfortable with the stocks (or indices) we often trade and often miss opportunities outside of that comfort zone for fear of the unknown. Change isn’t only positive, it’s inevitable.
8. Negativity Bias
Let’s face it: We live in a sensationalist society where scare tactics and negative headlines garner the most attention. If you doubt this for a minute, turn on your local news tonight. Scientists theorize that we perceive negative news to be more important than positive news. The risk—for the bears and for humans as a whole—is the tendency to dwell on bad news rather than embrace good news, and there’s the added twist that the stock market is widely considered to be a leading indicator.
9. Bandwagon Effect
How prevalent is this when it comes to the financial markets? They teach it in college as a stylistic approach (momentum investing)! Nobody in our business—or in the media—wants to miss a move in the stock market, and history is littered with bubbles and busts that demonstrate this bias in kind. In life, this is driven by our innate desire to “fit in and conform"; in the markets, it’s driven by two factors: fear and greed.
10. Projection Bias
This is predicated on projecting our thoughts and beliefs onto others and assuming that others are wired the same way (they’re not). This can lead to "false consensus bias," which not only assumes that other people think like we do, but that they reach the same conclusions. In short, this creates a false consensus, or sense of confidence when in fact one doesn’t, or shouldn’t, exist.
11. The Current Moment Bias
This is a direct descendent of the immediate gratification mindset that dominated society for many years—and some will argue that the government is currently operating in this mode, mortgaging our children’s standard of living to achieve short-term fixes. In short, we want to live as well as possible and pay for it at a later date (as evidenced by the level of debt and our growing deficit). The housing crisis was rooted in this bias, as is the basic concept of leverage.
12. Anchoring Effect
This tendency, also known as the relativity trap, compares a situation to a limited sub-set of information; it’s when we focus on a number or value and extrapolate it to a current situation. This often manifests in the marketplace through the fundamental metric, when we observe that a stock is “cheap” relative to its peers or a historical precedent (also known as a “value trap”).
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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