There are several cognitive biases that influence the decisions of all types of investors, especially in times of recession and anxiety. AlphaStocks wants to tell you what prejudices exist, what this means and how you can take them into account.
It may sound a bit over the top, but when it comes to investment decisions, being as unemotional as possible is generally a good tactic. Too often, investors get caught up in the short-term narrative driven by the media or the opinions of others.
These are three biases that all investors should be aware of.
1. Confirmation preference
Perhaps the most difficult thing for us in our daily lives is confirmation bias (confirmation preference). This is the deliberate search for information that is beneficial to your opinion or situation. For example, if you own Ford stock, you might be looking for “Why is Ford a good investment?” to strengthen his position. Instead, you’re better off looking “Why is Ford not a good investment?”
It goes back to my point of being impassive when making decisions. You want to know why a business might fail, so you can factor this into your investment. Hyped stocks like Palantir, Nio, and Gamestop are so beloved by investors and praised to such an extent that investors ignore the bigger picture and the visible risks involved in these companies.
The media often press us with a short-term story. Minute-by-minute access to news has only increased the chances of getting news personalized to you. In certain circumstances, irrelevant news appears before us with the aim of provoking an emotional response in us as readers, listeners and viewers. But in reality, stories usually don’t hold attention for more than a few days, weeks, or months before the market moves on to the next big story.
What is much more useful for investors is to keep track of the most important information relevant to the companies in which they invest and to be aware of all the key implications that could affect the long-term prospects of an investment.
Don’t be fooled by price fluctuations if they don’t affect the performance of your investments and always check the sources from which you get your information. Multiple sources with unique points of view are always the best way to come up with an unbiased summary of the event in question.
3. Reference effect
anchor bias, also called the reference effect, is perhaps the most relevant of all on this list in the current circumstances. Benchmark value tends to sway investors in justifying an opportunity even when circumstances have changed. In 2021, for example, the speculative bull run led to reckless and undeserved valuations with years of unproven growth built into the valuations of countless companies.
Given the rise and fall of many stocks, especially growth stocks, investors tend to believe that all stocks will eventually return to their all-time highs. This will be the case for some but not all stocks. Many of the companies that have gained momentum in recent years still have no revenue, no long-term viable business model, no competitive advantage, and mountains of debt.
Sorry to be the bearer of bad news, but some of these stocks will go bust.
We all know what it is like when we start investing; “Past performance is not an indicator of future success.” That’s why our job as investors is to make informed and calculated decisions that maximize the probability of a successful outcome, minimize risk, and hopefully deliver positive long-term returns.
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