- Posted by DynamicHedge on November 21st, 2014 at 1:34 pm
This series might sound like a crazy rant against using your gut instincts to ever make investment decisions. In fact, when we first put this list together that was EXACTLY how it seemed. But when you step back and think about it you’ll find that these are called belief perseverance biases for a reason. They are only concerned about what happens after you make a decision or acquire a belief. What led you to the original decision is of no consequence (yet). At this point, we only want to test the decision in an objective way to verify that it is still the correct path.
Confirmation bias is when people only look for information that confirms their current beliefs or they ignore or dismiss information that contradicts their beliefs. Confirmation bias and conservativism bias can go hand in hand. An investor uses confirmation bias as the method in which they discredited or disregard new information that would otherwise cause them to update their previously held beliefs.
When you think about it, confirmation bias is a very natural way to deal with an uncomfortable mental situation. We tend to like things we already agree with, so when we hear a bunch of new information it’s not surprising that we overweight the stuff we already “know” to be true.
Confirmation bias is particularly hard because the only antidote is objectivity, which is fundamentally impossible when you have made an internal decision. The act of making the decision precludes any possible objectivity.
The only way that confirmation bias can be effectively overcome with a commitment to seek out challenging information. But, even that isn’t a guarantee that you won’t thoughtful ponder this new contrary information and just disregard it.
Have you ever caught yourself sneaking in or omitting a criteria into a stock screen or other database lookup because in the back of your mind you know that with/without that criteria you will not get the answer you want? Well, if you have you are probably guilty of confirmation bias. It’s best to stop the instant you find yourself doing that and take a few steps back to reassess. We have all done this at one point or another. Since you can remember doing it now, you can consciously stop yourself from doing it in the future. This isn’t easy, and this paragraph will now haunt you for the rest of your decision-making life.
Confirmation bias is impossible to prevent. You WILL unknowingly look for information that supports your views. Anyone claiming to be completely objective about their own decisions is a liar.
Actionable steps: There is no panacea but you can take a bit of the edge off. The way to reduce confirmation bias (remember, impossible to eliminate) is to trust in numbers more than your trust your yourself. Admit that after you make a decision, your ability to objectively evaluate new information is reduced. Decide on a quantifiable method you are going to use to evaluate the decision later (before too much time has passed). Not only does this metric have to be quantifiable, it also has to have boundaries. When the numbers breach a boundary and make you all annoyed because they are contradicting your opinion, go with the hard data rather than your fragile ego. The other trick is to apply a different set of decision criteria than what you used to make the original decision. Sometimes casting a wider net and expanding your research can help with objectivity.
Conservatism Bias: How to know what new information to focus on
Posted by DynamicHedge on November 20th, 2014 at 2:20 pm
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Pardon the interruption
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The chart below is from a report I ran on early in the week while watching, in mild disbelief, the market march higher. The study examines all post-crisis […]
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Ebay Monster Gaps
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Posted by DynamicHedge on September 8th, 2014 at 9:01 pm
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Posted by DynamicHedge on August 20th, 2014 at 1:44 pm
Despite all the public worries about the market, the $SPY is on the cusp of making a brand new 52-week high. I ran a quick study […]
DynamicHedge is an equities, futures and derivatives trader based on the West Coast. He runs a long/short opportunistic relative-value strategy within a proprietary trading group. More
- Confirmation bias: A dependable filter of objective information
- Conservatism Bias: How to know what new information to focus on
- Sentiment Flip
- Pardon the interruption
- Wait for the market to flex
- How SPY typically trades after a gap up/down on NFP report
- Ebay Monster Gaps
- Ghosts of Death Cross Past
- Yahoo Strategy Ahead of Alibaba IPO
- 3 Important Things To Watch For At 52-week Highs