Confirmation bias
When you own a stock, you unconsciously look for news that confirms the purchase and skim over everything that speaks against it. The market often punishes that.
Learning objective: After this lesson you'll recognize confirmation bias in yourself and know how to counter it.
As soon as you've bought something, you change. News that supports your decision seems convincing. News against it seems exaggerated or written by people who haven't understood.
How Your Surroundings Amplify It
Your surroundings amplify this. When Ben buys a stock, he soon follows people who like the same stock and watches videos by fans. After a few weeks he hears almost nothing but agreement.
The Question Before Buying
That's why, before every purchase, one question matters more than why it's good: what would have to happen for me to be wrong? If you have no answer to that, you don't have an idea behind the purchase, only a hope.
Writing Down Two Sentences
A practical trick: before buying, write down two sentences. Why you're buying, and how you'd recognize that you were mistaken. The second sentence is the more valuable one.
Confirmation bias works in three places. We choose sources that agree with us. We consider evidence for our view stronger than evidence against it. And we remember better what fits. Together this means the more you read, the more certain you feel, without your judgment getting any better.
The Endowment Effect
Then there's the endowment effect. Just because you own a stock, you think it's worth more, even without new information. If you've put a lot of time into the analysis, you also don't want that work to have been for nothing. But those sunk costs have nothing to do with whether you should hold the stock today.
A Written Check
What has proven useful is writing down before the decision how you'd recognize your mistake. Because it's on paper, you can't talk yourself round later. A related method is the premortem. You imagine that the decision has clearly failed a year from now and write down the most likely reasons. That often brings up risks you'd overlooked.
Summary
- More information makes you more certain, not more accurate.
- Before buying, write down how you'd recognize your mistake.
- Sunk costs don't belong in any decision today.
Did you get it?
Where does confirmation bias work?
In choosing sources, in weighing evidence and in memory.
What is a criterion for your own mistake?
An event fixed in advance by which you'd recognize that your idea was wrong.
What is a premortem?
You imagine the decision has failed and collect the most likely reasons beforehand.
Check your understanding
Your task
Pick an investment you own or want to buy. Write two sentences: why you are buying it and what would show you that you were wrong. Then find a source that says the opposite and note one argument from it.
Sources and further reading
- Nickerson's foundational review of confirmation bias, summarizing how it operates through source selection, the weighting of evidence, and memory. View source ↗
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