How to recognize confirmation bias
Remember the analyst that never even considered news that wasn’t positive about his favorite stock? Think about the analyst who had a “strong buy” on Enron when the share price was at $90 in mid-2000 and continued to say “buy” as the stock crashed to less than a buck by the end of November 2001. That analyst wasn’t really open to opposing news or arguments.Image source: The Blue Diamond Gallery
Or what about that friend on Facebook that blocks all friends that post or share content with opposing political views? Heck, maybe you’ve even done that before? ?
What is confirmation bias?
Confirmation bias is the tendency to only search for and put weight on information that confirms your beliefs. The guy who still had a “buy” recommendation on Enron when other analysts and reporters started to question the company’s accounting standards refused to listen to anyone other than Enron’s own executives.
Or let’s focus on your friend who’s convinced that Hillary Clinton should have been the President of the United States and blocks his friends who are Trump supporters. Your friend is making an active choice to avoid opposing views, and in the end, is only going to see supportive posts in the Facebook feed.
Why is confirmation bias a problem?
You may ignore information that contradicts your belief. And this is an issue because you will stay convinced of an idea that might turn out to be wrong. Once again using the case of Enron, before all the dirty stuff was known, you might have done research and everything looked good. But when new opposing information came out, and it turned out that Enron was fraudulent, the right move was to change opinion. If not, you’d have lost the majority of your investment.
In our current time, it’s was reported in February that short sellers have lost $2 billion betting against Tesla’s stock this year. Traders remain certain that Tesla, which is currently only beginning production of their first mass market sedan, the Model 3, shouldn’t be worth more than Ford. While short selling is always a gamble, these traders need to remain cognizant that Tesla founder Elon Musk has a long history of disproving low expectations.
How to deal with confirmation bias
Always be open to opposing views, strive for objectivity and put your ideas to the test. With many things in life, and certainly in investing, objectivity and rationality are key. Being open to opposing views is not about always being proved wrong, but keeping an open mind and taking opposing views into account may also strengthen your view. The key is to strive for objectivity and truth, not what’s most convenient.
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Article by Alexander Wetterling, Become A Better Investor