If someone tells you that the
What is a cognitive bias?
Cognitive bias is a deviation from the rationality when we make certain decisions. There are many types of cognitive biases, but we will only cover a few in this article. Example of a cognitive bias is the anchoring bias. The anchoring bias is when we mostly base our decision around the first data point that we are given. For example, if you do not know the price of suits and the first suit that you’re shown is a suit with a price tag of $600. You will subconsciously base the price of all suits around that price (hence where the name “anchoring bias” comes from). If the second suit that is given to you is $300, then you are more likely to perceive the second suit as cheap regardless of your financial situation. If we reverse the situation and the first suit that is shown to you is a $100, but the second is $300, then your reaction will be the opposite (even though the second suit is always the same price = $300). This time, you will perceive the second suit as expensive. This bias is very frequently used by people trying to sell something to you. First, they will offer something that is more expensive and then they will show something which is less expensive relative to the first one. The first price is the one that you will “anchor” yourself about this topic, hence the second suggestion will always be compared to the first one. The equivalent in the stock market is to first see the price of a particular stock when it was trading at ATH (all time high). When you see the current price, you will say that the stock is trading at a discount, but that is more often false than true. That is why in most stock graphs the following message is displayed.
“Past performance is not indicative of future results.”
The other, arguably most biased bias in stocks is called “Groupthink”. Simply said, this is the intrinsic feeling that we have for conformity. We want to belong to the group, so we tend to agree with what the group thinks. Since that improves our chances of staying within the group. Looking back at our ancestors, staying in the group was equal to surviving. Since our ancestors were hunter-gatherer groups, leaving the group meant that the chances for the individual’s survival dropped exponentially. In the stock market, we often tend to agree with what the general public thinks about a certain company. For example if the company is disliked by the investors, we tend to not invest in the company. Therefore people who can think for themselves can spot the inefficiencies of the market and are usually the winners. Not agreeing or agreeing with the other investors doesn’t make you right. Being able to think and judge for yourself, independently of what the group thinks is what increases your chances of being right. If we take “Bitcoin” for example, many people in its early stages believed that Bitcoin will fail. They thought that this is a temporary trend that would disappear after some time. Those who were able to think critically and independently of others saw the potential of “internet money” and decentralisation. The same people most likely to read the white paper, understood the idea behind “proof-of-work” and how revolutionary the technology is. Which in the best case scenario resulted in them buying/holding bitcoin through the years, making them thousands of percentage gains. What I am trying to say here is that, agreeing nor disagreeing with the group by itself will make you right. But not always agreeing just because the group says it, will at least give you the chance to think of it for yourself and then make a personal decision instead of relying solely on the group’s brain. Back to the bitcoin example, you could have disagreed with the public back then and made your own research and then came to the same (as the general public) conclusion that Bitcoin will fail. And that’s still many times better than just going along with the public and not thinking for yourself. Because in that case you might miss a project or two, but you will still have better chances to capture a golden or 100x idea.
The third bias that I want to mention in this article is the “Confirmation Bias”. In essence, we remember information that we agree with or confirms our perception. If we find something that we do not agree on, then we easily dismiss it. That makes it very hard to understand other points of view and needless to say that is essential when making an investment or any other decision for that matter. In the best case scenario, a person should be able to look at both perspectives, analyze them and only then judgment should be made. Otherwise, you fall to the trap that you only keep believing in the old ideas that you once had. And one idea might serve you very well in one period of your life, but as all things change, it might not be best suited to other periods. Ideas or beliefs in my opinion, should be always re-evaluated. And if you are not aware of the confirmation bias, it will be really hard to fight against it. You will keep reinforcing the old ones, making it even more difficult to change them. Improving is all about being open to new ideas, you do not have to always agree to them, but at least consider them.
Not financial advice.
New to trading? Try crypto trading bots or copy trading