|Rationalization in Stock Trading|
Creating the most appropriate and profitable investment strategy is not an easy task. In fact, your investing may be compounded by natural human psychological tendencies, such as confirmation bias and investor herding. By stepping away and reviewing the larger picture, you can maintain your behavioral intelligence in trading – and not fall victim to the psychological downfalls of investing
The trouble with confirmation bias
Simply put, confirmation bias is the psychological inclination to only see the evidence that supports your own presumptions, also known as rationalization. Research is a critical part of your investment strategy, and thus, you must appropriately find and analyze relevant financial information. However, during this process, you will naturally develop an opinion.
The trouble with confirmation bias is when the human mind begins to take the developed opinion to the next stage. Once the opinion has been formed, the human mind will filter all of the other incoming information – seeking specifically information that will reaffirm the original conclusion.
For example, an investor believes that REITs will rise because all of his research thus far has pointed in him that direction. Therefore, the investor will continue his research, seeking out information that will further confirm his analysis. In the process, he loses out on analyzing important facts that indicate that REITs are on the decline.
Confirmation bias can become a large hurdle to investing profitably. It is a powerful bias, one that even market experts fall victim to from time to time.
Avoiding confirmation bias in your trading
For the retail investor, a great risk of confirmation bias stems from the advice that market “experts” provide. It is critical that you review all of the market expert’s advice with a grain of salt, understanding that they each have their own confirmation bias troubles. In fact, it is best to analyze opposing viewpoints, as this will allow you to properly weigh the facts and arguments.
You have to learn how to think for yourself as an investor. Are you really smarter than the informed experts who make their living studying the stock market? Or are you becoming a victim of confirmation bias and believing what the experts want you to? Protect your portfolio from the human fallacy of confirmation bias. Examine both sides of the argument, both in terms of your own opinion and the experts. The more knowledge you have, and the more you force yourself to seek out opposing information, the more profitable your portfolio will become.