Confirmation Bias – In search of supporting-only information


Confirmation Bias
In investing, the confirmation bias suggests that an investor would be more likely to look for information that supports his or her original idea about an investment rather than seek out information that contradicts it.

As a result, this bias can often result in faulty decision making because one-sided information tends to skew an investor’s frame of reference, leaving them with an incomplete picture of the situation.

www.investopedia.com

As humans we all have preconceived opinions, hence we selectively choose news and information that supports our opinions and ignoring the rest. This type of thought process is called as the confirmation bias.

That is, the human tendency not only to hear what we want to hear but also seek for information to prove those information.

Confirmation Bias in stock markets

For example, an investor may get a news or information about a stock and its potential to move up in the short term. From then on he will be looking for information to prove this point of view, and he may unconsciously or wilfully ignore any news or information against this. Hence, he will collect more such positive supporting information and then even go ahead and invest in that stock.

For example, an investor who might have bought a stock which had fallen heavily and sitting on huge losses will also look for positive news and information about the company, just to support his decision to hold on to the investment to sell at a profit in the future. Eventually, the stock may not go up at all and still the investor will search for some good news somewhere to support his decision to hold the stock.

Those who fall victim to this bias and investing in asset classes, will pay dearly for their decisions. They even hold on to their investments even far after they should have exited them.

How to overcome Confirmation Bias?

  • Always understand that there cannot be single source of truth in investing
  • Only sound fundamental analysis and critical and contradictory thinking will provide you with proper data to make proper decisions
  • Understand you cannot always win the markets
  • Understand your risk taking ability and have proper margin for loss in case it occurs
  • Intentionally look for contradicting information and analyse them
  • Always have margin of safety in your investments
  • Always have stop loss in your trades

My Experience with confirmation bias:

I entered Opto Circuits when it was trading at Rs.150. Then the stock fell down and upon analysis I came to know that their aggressive inorganic growth has stressed their balance sheet with debt. By this time stock was trading at Rs.100, and I bought again. I was of the understanding that the company made superior products in medical space and read reports that once the economic situation improves and interest rates come down, it will be good for the company. In the meantime, I was buying at every fall. By this time the stock was trading at Rs.49, and I bought again. Now, I have the average investment at Rs.76 and sitting on 69% loss. All through this, I was looking for good news about the company and I was also getting them and using them as a support for me buying into the stock at every fall.

You know what, I am still sitting on the hope that the company’s fortunes will revive in future and will get my anchored price of at least Rs.150 (anchoring bias :))

“It is the peculiar and perpetual error of the human understanding to be more moved and excited by affirmatives than by negatives.” – Francis Bacon

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so” – Mark Twain

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Filed under Behavioural Finance

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