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Believing is Seeing in Investing

Dr_Reid-name

“The human understanding, when it has once adopted an opinion…draws all things else to support and agree with it.”- Francis Bacon

One of the most ingrained foibles of human cognition is the tendency to see what we believe. It’s called the confirmation bias.

The Misconception: Our opinions about the market are the result of  balanced, rational analysis.

The Truth: Our opinions about the market have been formed by attending to information that confirmed what we already believed while largely discounting facts that challenged our preconceived notions.

Confirmation bias causes us to see what we want to see or expect to see, whether it is there or not. If it is there, it will pop to the foreground; if it is not there, we will simply create it.toyota

For example, if you are thinking about buying a new Camry, you will constantly spot Camrys as you drive around. You won’t be able to stop seeing them; they will intrude on your sensibility at every turn. And yes, those Camrys really exist (they were there all along, but you just didn’t notice.)

And if you believe the market is way too high, every downdraft on a 15- minute chart will be an omen of “the crash.” This is your imagination distorting reality to confirm your apocalyptic bias. (Hindenburg!)

According to research done at Ohio State University, confirmation bias causes us to spend about 1/3 more time selectively reinforcing what we already believe than on material that might dis-confirm our preconceptions.

And the rabbit hole goes rather deep. As humans, we seem to need to be right to prop up our self-image.

That means we have a blind spot when it comes to information that disconfirms our beliefs because it actually challenges our existential sense of security.

Trading, however, is a profession where we constantly put our security at risk. Therefore, in the service of self-soothing, confirmation bias is likely to be particularly rampant in traders. If you find that you can’t see the obvious until it is too late, reduce your risk (size) and reality will re-appear.

Until next time,

Kenneth Reid

Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.