Biases, we all heard at least about some of them. Here I touch upon a few which I believe are every day at play in the markets. If there is enough interest, I’ll reshuffle more notes into a second part (there are more than 250 different ones on the large print out hanging here on my wall). For now, enjoy these nine first ones. I hope to spark some self-reflection & welcome any personal stories.
Confirmation bias
We believe what we want to believe by favoring information that confirms pre-existing beliefs or preconceptions.
Live Example: Are the Australian fires caused by climate change or by the +180 locals that have been arrested for arson (the Australian & other sources)? It’s way to early and complex to make any conclusions, yet, social media are already filled with experts (cough cough) & their opinions. I can only assume this story fits perfectly in their beliefs. Personally, I’ve got no opinion yet (try it, it’s addictive). My heart goes out to all those affected. Humans, flora & fauna.
Alright, we started with a classic one so that is out of the way. Let’s move on.
Loss aversion
People’s tendency to prefer avoiding losses to acquiring equivalent gains. People like it better to avoid $5k than to gain $5k. Some studies have suggested that losses are twice as powerful, psychologically, as gains (Kahneman, D. & Tversky, A. (1992). “Advances in prospect theory: Cumulative representation of uncertainty”).
A graph of perceived value of gain or loss vs. strict numerical value of gain or loss. Note that a loss of $0.05 is perceived as a much greater loss than of a comparable gain of $0.05.
For example, when asked to choose between receiving $900 or taking a 90% chance of winning $1000 (and a 10% chance of winning nothing), most people avoid the risk and take the $900. This is despite the fact that the expected outcome is the same in both cases.
However, if choosing between losing $900 and take a 90% chance of losing $1000, most people would prefer the second option (with the 90% chance of losing $1000) and thus engage in the risk-seeking behavior in hopes of avoiding the loss. Read more here
Moral: Stick to your playbook when you have virtual losses, don’t panic and avoid making the situation worse by taking on more risk to win those losses back. A recipe for disaster. Both on the stock market as in the actual casino.
Recommend reading: “thinking fast and slow” – D. Kahneman
Risk compensation
Risk compensation is a theory which suggests that people typically adjust their behavior in response to the perceived level of risk, becoming more careful where they sense greater risk and less careful if they feel more protected.
While counter intuitive, the opposite approach can be the more effective one. Example: Shared roads. Creating a greater sense of uncertainty and making it unclear who has priority, drivers will reduce their speed, reducing road casualty rates, and improving overall road safety.
In Investing, this could manifest as an over allocation of a stock due to the perceived feeling of having all bases covered. In the opposite direction, many profits were missed in 2019 by simply avoiding riskier jurisdictions without further evidence based due diligence.
Blind spot bias
Viewing oneself as less biased than others.
Just because, you know, you’re different… No you are not. One example: How many car drivers do you think assess their own driving skills as ‘above average’…
Stay humble and self reflective. Use counter arguments as a way to test and strengthen your due diligence, not to use the ignore button.
Which brings us to the next one…
Illusory superiority
A person overestimates their own qualities and abilities, in relation to the same qualities and abilities of other people.
Do your own due diligence, just stay humble and acknowledge you are not the expert in any given field, let alone in assessing all the different components together. Stay open to learn
Belief bias
Basing the strength of an argument on the believability or plausibility of the conclusion.
One that is often seen in the junior mining investment space. Due to the complexity of some information (think a technical/geo news release), we often search for expert opinions & conclusions. In the press release itself and/or on social media. Again, know who you are listening to (credentials & incentives).
Belief revision
A bias in human information processing, which refers to the tendency to revise one’s belief insufficiently when presented with new evidence. This bias describes human belief revision in which persons over-weigh the prior knowledge and under-weigh new evidence.
Ah, the juicy one for any speculator. Interpreting news releases and assessing their implications ON THE SPOT are the very valuable skills in this market. Fund Manager Willem Middelkoop revealed in a recent podcast that his edge is that when his team spots an important news release, they clear the agenda and pull an all-nighter if needed to do just this. Get early on the right side of the trade.
Endowment effect
The fact that people place a higher value on a good that they own than on an identical good that they do not own ( Kahneman, D.; Knetsch, J.; Thaler, R. (1990). “Experimental Test of the endowment effect and the Coase Theorem”).
why are we ‘defending’ stocks we own more than the ones we know but don’t own? Why is my portfolio different than those of people I respect and value higher than myself? Can a company successfully find a way to tap into this discrepancy?
Hindsight Bias
The common tendency for people to perceive events that have already occurred as having been more predictable than they actually were before the events took place.
Very real in the exploration field. Always keep in mind, all the preparation work for drilling is intended to, is to increase the probability of hitting the most probably place where mineralization could occur. You cannot expect them to hit, you can only assess if they did all they could to assess the best spot to put the drill. Lots of ifs and buts here.
Hindsight bias may also cause distortions of our memories of what we knew and/or believed before an event occurred, and is a significant source of overconfidence regarding our ability to predict the outcomes of future events. Yikes.
The IKEA effect & sunk costs
The IKEA effect is a cognitive bias in which consumers place a disproportionately high value on products they partially created. Experiments by Norton and his colleagues demonstrated that self-assembly positively affects the evaluation of a product by its consumers (Norton, Michael; “The IKEA effect: When labor leads to love”).
You build it and it makes you feel competent. Additionally, as the supplier took out the labor cost to sell it to you on the cheap, you also feel a smart buyer. Great business model isn’t it?
Could you draw a parallel to your investments? Any trouble selling a stock you intensely researched and maybe even recommended to friends or family?
Your spent hours researching are a sunk cost, get over it.
Cheers, Pete
