Confirmation Bias

Confirmation Bias

At its most basic and rudimentary level, confirmation bias can be described as only hearing what you want to hear. To expand in a bit more depth, it’s the human inclination to give more weight to things that match one’s own beliefs and less to that which contradicts. This can lead us to avoid seeking objective facts, only remembering what maintains and upholds our beliefs, and ignoring information that may challenge them. It even goes beyond that to actively seeking out information that confirms these pre-existing beliefs. 

What this means is that the information we seek, receive, and remember is subconsciously biased based on our personal perspectives and viewpoints. Examples can range from the innocent — if you believe that left-handed people are more talented than right-handed, anytime you come across a talented left-handed person, you will log it as proof, while you may ignore talented right-handed people — to the extreme — confirmation bias is one of the key factors of forming and confirming harmful stereotypes across the globe. 

It can even have deadly consequences. This excerpt is from ‘Psychology’, by Peter O. Gray: 

“Confirmation bias can couple with the availability bias in producing misdiagnosis in a doctor's office. A doctor who has jumped to a particular hypothesis as to what disease a patient has may then ask questions and look for evidence that tends to confirm that diagnosis while overlooking evidence that would tend to disconfirm it.”

Social media has exacerbated the issue of confirmation bias as billions of people have formed their own personal echo chambers, filled with like-minded people and media sources that conform to their own points of view. But social media sites are not the cause of confirmation bias, rather they just allow individuals to facilitate it, unfortunately, to the nth degree. 

So we know that confirmation bias is an omnipresent issue; how can it affect us in our investing careers? Well if investing is a series of decisions based on the best information we can find, a subconscious part of our brain directing how we source, interpret and remember this information may be a bit of an issue. It can lead us to seek out subjective information that paints businesses we own or want to own in a good light. It can force us to ignore contradictory opinions that may contain important facts about the business. And ultimately, it can lead to missed opportunities, narrow focus, and making decisions based on incomplete information; all very expensive habits.  

Let’s take an example of two talking heads on CNBC arguing the bull and bear case for a stock you own. Because of your own research and the investment thesis you formed before buying the stock, you are going to agree with the person presenting the bull argument because they mirror a lot of the beliefs you hold. As we’ve already established, it’s your natural inclination to immediately downplay the person championing the bear argument too. However, because one side of the argument is right (in your head), does not mean the other has to be wrong. In this example, the bear argument could actually be more beneficial to you as it gives you a more rounded view of the business, rather than repeating something you already know. 

In fact, it is a good idea to ingratiate the bear argument of a stock into your research. By knowing the potential downfalls, you get a comprehensive viewpoint and can gauge the severity of the risks involved, rather than just focusing on the upside. At a time like this when many of your portfolios may be taking a hit, knowing and being OK with the bear argument provides reassurance when a stock is in the red, as it’s easy to diagnose the dip. If you can answer the question: “is this stock down because of wider market sentiment or is my investment thesis at risk?”, then you will not only become a better investor, but you will also save yourself endless amounts of stress and effort wasted fretting over volatility. 

Applying this open-mindedness beyond individual stocks will also go a long way to making you a better investor. If you classify yourself as a growth investor, I implore you to learn more about value investing. If you’re a stock-picker, read up on indexing. If capital appreciation is your only goal, figure out the ins and outs of dividend investing. By learning the reasoning behind the opposing view of your particular investment style, you will gain a greater perspective on the wider market, as well as what makes you tick. 

Morgan Housel has always said that in the stock market, everybody is playing a different game to you, with different goals and outcomes. We practice a long-term buy-and-hold strategy here at MyWallSt, but that doesn’t mean we can’t learn from hedge funds or traders. Being able to recognize confirmation bias and keep an open mind is one of the key factors in taking the next step in your investing career.

MikeMike

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