Have you ever noticed that people tend to remember and interpret information in a way that confirms what they already believe? This is a very important cognitive bias known by several names, most commonly, CONFIRMATION BIAS.
The most important characteristic of confirmation bias is that — as odd as it sounds — the stronger the belief, the stronger the bias. This is why, in public discourse, the most highly charged topics (for example, gun control, abortion, global warming) stimulate the most biased opinions and actions.
Why does confirmation bias exist? It is not the case that human beings are biased towards confirming what they already believe, because they are unwilling to look at any evidence to the contrary. The actual explanation answer is more subtle.
The truth is, most people are willing to listen to opinions different from their own. (This is why there are so many arguments.) However, during such arguments, people tend to listen in a one-sided way, focusing only on the evidence that supports their point of view, while ignoring alternatives that might prove them wrong. Thus, confirmation bias is caused, not by ignorance, but by poor listening skills.
Confirmation bias is so common and so powerful that, as in investor, it can severely limit your ability to make independent, rational decisions. As such, you must come to terms with it. Specifically, you should train yourself to recognize confirmation bias in your thinking and — once you recognize it — to force yourself to consider alternatives.
The easiest way to overcome confirmation bias is to deliberately seek out opinions and information that differ from what you want to hear. In practice, there are two good ways to do this.
First, before you make any important financial decision, find a strong-willed, knowledgeable person who is willing to listen to your ideas and argue against you.
Alternatively, if you have enough maturity, you can force yourself to be a devil's advocate and do your best to pick apart your own opinions, trying to see if you can prove yourself wrong.
As an example, let's say you have done a lot of research and have identified a stock you think is undervalued. The stock, you believe, has a good chance of going up over the next few years. Before you invest, see if you can find a smart, knowledgeable person who likes to argue. Present your findings to him or her, set aside your ego, and invite that person to point out your mistakes. (This, in a nutshell, is what scientists must do before their ideas will be accepted by other scientists.)
There is no doubt that arguing with such a person can be frustrating. Moreover, if he or she succeeds in finding significant flaws in your research or your reasoning, you will probably feel foolish and embarrassed. However, feeling foolish and embarrassed is a lot more pleasant than what you will feel if you lose a lot of money, because a bias you didn't even know you had kept you from thinking well.
— Harley's Rule of Investing #8 —
The market doesn't care what you believe.
© All contents Copyright 2017, Harley Hahn