Behavioural Finance: Confirmation & Hindsight Bias

Confirmation Bias

Fundamental analysts or people who believe such reports need to be aware that they might be under the influence of Confirmation Bias. This is the tendency of people to favour information that confirms or matches their beliefs.

Lets say you are the ardent supporter of a political party. You would see that there are more and more news articles that confirm your views about how the party will win the majority in the elections or how the leader is the best thing to happen to India, etc. If your friend supported the opposite party, he would see more articles supporting his leader/party.

This doesn’t apply just for individuals, but also to organisations or even governments. They keep searching for information which supports their theory and would hate anyone who would say otherwise. They would even say the opposing view is false and wouldn’t believe it.

How does it affect Investors?

We as investors are heavily affected by it, especially if you base your investments on someone else’s analysis. Numerous analysts publish reports about stocks and why it is a good investment strategy. Once you made your decision to invest in a stock, you would look for reports and news which support your decision.

You would read how all analysts are taking how good the company is, how cheap the valuations are, etc. You would go out of your way to prove that your investment was the best decision, even though the company might not have customers or revenues to match the high price.

HindSight Bias

Hindsight is 20-20You know how they say hindsight is always 20-20. This is also called the I-knew-it-all-along effect. After a disastrous event has occurred, you would see many people proclaim that they knew it was bound to happen all along, even though there was no way they would have predicted it.

There were numerous bubbles in the history – tech bubble, sub-prime crisis, even the tulip bubble. Every time after the event numerous experts came out saying “We knew this would happen all along. It was just a matter a time.”

In stock markets, this could be very dangerous as it makes the trader/investor to feel overconfident. When you keep picking numerous stocks which gives you good returns, you would soon believe that you have superior stock-picking skills.

Avoiding these biases

To avoid both these biases, it is important that you realise that what you read is not always true. If you want to invest in a particular stock, instead of reading reports and articles that praise the stock, try searching for negative reports. Actively look out for reasons which would make you not to invest in it. Be the devil’s advocate and then invest if you still think its a good stock.

Have you ever had a similar situation where you knew or believed that you predicted something would happen? Tell me more about it in the comments below.

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