Recently, I’ve been doing a lot of research about the financial markets and different investment instruments.
I have a hypothesis and opinion about what I think is right, but I can’t just rely on a hunch if I want to be successful.
When I started to research and started reading a bunch of papers, articles, and books on the topics I was interested in, I kept finding what I was looking for and felt good about my original thoughts.
One of the principles I try to live my life with is having a skepticism about my thoughts and to look to challenge them if I’m not 100% confident.
Starting out, I was committing a common sin of researchers and investors: being affected by confirmation bias.
It’s human nature to be affected by bias. Today, I wantto share with you how I and you can overcome this faulty thinking and find the truth in the noise.
What is Bias?
First, before we get into some examples and how to overcome bias, I should introduce and define bias.
Bias is defined as follows:
a particular tendency, trend, inclination, feeling, or opinion, especially one that is preconceived or unreasoned
Unintentionally, humans have bias in their thinking from the day they are born.
Where is the best place to live? If the person you are asking is still living in the state they grew up in, I’m going to guess that person would say that state.
Again, this is human nature, but something that can be overcome.
There are many biases which can trap our minds, but for this article, there are two forms of bias that I want to call out and talk about:
- Confirmation bias
- Recency bias
What is Confirmation Bias?
Let’s talk about confirmation bias first.
Confirmation bias is incredibly important to understand in 2018 as many things portrayed and covered in the media is polarized.
Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses.
An example here (I’m going to go with politics for ease):
Let’s say you are trying to form an opinion about the current president. Maybe you are naturally a little bit right leaning, and you are trying to confirm or disprove your hypothesis that the current president is a good person.
Going to Google, you might type in something like “Is Donald Trump a good person?”. Maybe you type in “Is Donald Trump a bad person?” There’s many different things you could type in.
(if your blood is boiling at this point, this is just an example… maybe I should have stayed away from politics)
Confirmation bias is basically that whatever you are looking for, you will find it.
If you think Donald Trump is a good person, you will naturally side with information that confirms (hence confirmation) your position that he is a good person. If you hate him as a person, then any information you come across that could disprove your opinion.
While I’m not going to share my opinion on this matter, I want to highlight confirmation trapping our thinking and thought processes because this is real and happens every day.
Let’s talk about another form of bias now.
What is Recency Bias?
Recency bias (also known as selection bias), is the tendency to overweight recent information in your thought process (or overweight information which you have cherry picked to support your point).
An example of this might be the following:
Let’s say I’m trying to form a view on the stock market’s future movements.
I might think that it will go up in the next year, so I want to invest more.
Looking at charts and data, I might look and see, well, in the past year, it’s gone up, so I’m going to ride the wave of momentum and stay invested.
I put “in the past year” in bold, because this illustrates the concept of recency bias: I cherry picked 1 year because it was convenient for my hypothesis.
What happened in the year before? What about the 10 years before? Were there any factors influencing market performance in those periods which may or may not have an influence in the next year?
There are many things to consider when doing this sort of thinking and reasoning.
Examples of Bias in My Thought Process
Recently, I’ve been waayyyy down the rabbit hole.
Like I said in the intro, I’ve been looking at financial markets and different investment instruments.
This is my personal opinion, please don’t make any investment choices off of this discussion. I’m not a financial professional and this blog is for entertainment.
My main hypothesis is that we are at the top of the credit cycle and market, and the risk/reward is not favorable to being in stocks.
What I noticed is that when I started doing research, I kept landing on doom and gloom sites.
“BUY GOLD”, “MARKET CRASHING BE PREPARED” – things I kept seeing and I thought my hypothesis was correct.
Part of critical thinking is realizing your biases and being careful in your thought process.
After landing on these sites, I had to dive deeper and think harder. I was becoming a victim of the confirmation bias.
If I wanted to fully vet my hypothesis, I would have to look to the other side: could the stock market keep going up and if so, why?
In addition to trying to avoid being biased by confirmation, I’ve also looked to not just look at recent data, but data in history.
After all, history doesn’t necessarily repeat itself, but it does rhyme.
As of the last few days, I’ve moved to examining previous market crashes (US Markets 1987, 1997, 2001, and Japanese Market 1989 in particular), to try to tease out any common relationships between then and now.
I’m still searching, but I’m feeling better about my thoughts because I’m avoiding bias and not being trapped in an echo chamber.
How to Overcome Bias in Your Thinking
For you, first, it’s good to recognize these biases and understand that they are human nature to be trapped by them.
Next, thinking critically and considering what else you could incorporate into your thought process is important to make sure you don’t fall back into the previous trap.
I hope you’ve learned some interesting points to consider in your life, and have enjoyed this article.
Readers: are you inadvertently employing bias in your thinking? What do you think you can do to overcome this bias?
Erik
