The confirmation bias in the world of equities
Reading time: about 5 minutes
Referring to my previous posts on the topics of.
Sunk Cost Fallacy https://getqu.in/VbkjSa/ and
Ultimatum Game https://getqu.in/3swaOa/
today follows a post on the confirmation bias.
What is the confirmation error
People tend to unconsciously support their own behavior and views with such information by which they are confirmed. If you think party X is making good policies, you will look for information (news, posts on the Internet, other people with similar opinions) that confirms your assumptions. You will inevitably also come across information that represents a contrary opinion, but you will selectively block it out or judge it as false, incorrect, lied. Especially in the last years you could observe this in the context of Covid19, where (alleged and real) experts constantly contradicted each other.
One runs the risk of selecting important information, distorting it and adapting it with regard to one's own opinion.
Where can we encounter confirmation bias on the stock market?
In the consideration to buy stock Y, one looks for information about the company. Bad economic data/company figures, which objectively speaking would perhaps prevent one from buying (usually unconsciously), are faded out. Instead, they focus on information that reinforces their own opinion or their desire to buy share Y. Starting points here are, for example, portals such as reddit, where hypes, meme stocks and fomo news seem to be popular and are shared and discussed in large quantities.
Recent examples of this could be the meme stocks that have been popular for about two years now $GME (+0,5 %) and $AMC for which large communities have come together on reddit. Keyword: Herd instinct
Interpreting company figures according to one's own opinion is a good example of confirmation bias. A negative quarterly report from company Y with a subsequent drop in the share price could be misinterpreted as temporary weakness and at the same time a great opportunity to enter the market - or vice versa. People ignore warning signals in order to justify their original (here: buying a bad stock) decision and, again a human tendency, to show consistent behavior at the same time.
Information that confirms one's own opinion is often accepted uncritically and without further verification. One succumbs here possibly to the confirmation error, by telling oneself that one already knew what was confirmed to one now also still. Affect heuristics follow the same line. This states that decisions are often made on the basis of emotions, which was and still is helpful from an evolutionary point of view. According to this, one decides on the basis of one's gut feeling and tries to explain this decision with facts and arguments afterwards.
What do I want to achieve?
I have realized for myself that I have often succumbed to various thinking errors in the past, and I have paid a lot of lesson money because of them. In an attempt to avoid these thinking errors, I have started to deal with them and write down my thoughts - and subsequently share them here in summarized form. I look forward to constructive criticism of this post and helpful responses. Thanks for reading!
Related topics: selective perception; affect heuristics; targeted messages; consistent behavior; cognitive bias.
P.S.: In conclusion, confirmation bias is not an immutable law and not every person is affected by it to the same degree. The important thing is to be aware of confirmation bias (and other thinking errors) and to act accordingly, or to specifically look for other/opposing opinions and perhaps even try to recreate them in order to broaden one's own horizons. The goal should be to get rid of the idea that only one's own knowledge is exclusively fact-based and correct. As is well known, the truth often lies in the middle.
