Confirmation bias
Once you hold a position, you unconsciously look for information that supports it and overlook information that contradicts it. The market punishes that reliably.
The moment you've bought something, you change. News that supports your decision seems convincing. News against it seems overblown, or written by people who don't get it.
This gets amplified by your surroundings. Buy a stock, and you follow people who like the same stock. Before long, your entire information environment is agreement.
That's why the most important question before any purchase isn't why it's a good idea, it's what would have to happen for it to be wrong. Anyone with no answer to that has a hope, not a thesis.
A practical trick: write two sentences before you buy. Why you're buying, and how you'd recognize you were wrong. The second sentence is the more valuable one.
Confirmation bias operates on three levels: choice of information sources, weighting of conflicting evidence, and memory. All three reinforce each other and cause subjective confidence to rise with the volume of information consumed, without forecasting accuracy rising to match.
This gets compounded by endowment effects. Merely holding a position raises its subjective value, independent of new information. Combined with the effort put into the original analysis, this also creates a tendency to factor sunk costs into the current decision, even though they're irrelevant to it.
An effective countermeasure is formulating falsification criteria before deciding, paired with writing them down, which makes later memory distortions visible. A related technique is the premortem: assume the decision has demonstrably failed a year from now, and gather the most plausible reasons why.
Summary
- More information raises confidence, not accuracy.
- Decide before buying how you'd recognize you were wrong.
- Sunk costs should never factor into a current decision.
Did you get it?
On which levels does confirmation bias operate?
Choice of sources, weighting of evidence, and memory.
What is a falsification criterion?
An event defined in advance that would tell you your thesis was wrong.
What is a premortem analysis?
Assuming the decision has already failed, and gathering the most plausible reasons for it in advance.
Related
- Fear and greedStage 2
- The trading journalStage 2
- Calculating position sizeStage 2