I remember the time when I bought my first car. I went to the showroom with my mind fully made.
I had in fact already imagined myself owning and using that car. When I reached the showroom, I was so much filled with a ‘confirmation’ towards that product that each of its features made me think that I was about to make the right decision.
The chosen car’s design seemed the best amongst all other cars displayed. Its seat covers looked the brightest and softest. Its power steering and power windows seemed the most powerful of all. And its price seemed reasonable.
I had already confirmed the purchase in my mind and was seeing everything fit into that mould now.
You see, the way I behaved while purchasing the car holds true with most other expensive things we buy in life. We first make an emotional decision to buy such things and then try to find rational reasons to justify the purchase.
You know those moments when you get an idea, or make a decision, and everything you see seems to confirm your wisdom?
It’s probably not a sign from God! It might be ‘confirmation bias’.
The problem is that you probably can’t rewire your brain to avoid confirmation bias. But knowing about it can prevent you from making emotional decisions in haste – like quitting your job just because everybody is seemingly enthused about your healthy food restaurant business plan.
Confirmation bias and investing
Confirmation bias also plays a big role when it comes to investing.
When you buy a stock and it falls down after that, what’s your first reaction?
If you are like most investors, you tell yourself, “That’s just a temporary fall! I know the stock is very good and will do well over time.”
See, this reasoning is fine if you are holding on to a fundamentally sound stock. But if you realize that you have made a mistake buying that stock, and you don’t want to sell out at a loss, you look out for reasons that validate your thoughts.
You look for reasons that confirm you decision that the stock is good. You check out websites and message boards, spend time on business channels, or call up your broker to get his view.
And even before you are about to get that second opinion, you expect that it will confirm your own beliefs. If that isn’t the case, you look to another person’s views that will validate your decision.
In effect, this cycle repeats till the time you lose hope. And then you finally sell the stock at a huge loss!
This is typical of most investors. After having bought a stock, and then realizing that the company isn’t as good as was originally thought, an investor continues to hold on to it even if it is going down. He tries to find confirming ideas on why he is right in holding the stock.
History is a living proof that nothing has caused bigger losses to investors than their confirmation with their original but incorrect investment ideas. This has led investors to be overconfident, ignoring evidence that their strategies will lose money.
How to say, “No, thank you!” to your internal yes-man?
Just when you decide to buy a stock that you believe will multiply your money many times over the next few years, and you hear some positive news confirming your belief, you load up on that stock without blinking an eyelid.
What is happening in this case is that your mind acts like a compulsive ‘yes-man’ who echoes whatever you want to believe.
So if you believe that gold is the next hot investment, your mind will try to find all reasons that echo your core belief. The same holds true when you believe that a particular stock will double or triple your money.
You would then hear only good things about the stock, and would not bother about anything that challenges your hypothesis.
However, there are some ways you can let your mind, your brain, stop playing gains with you.
One of them is to share your investment idea with another person whose views you respect, and who isn’t invested in the same stock.
Ask that person whether he will sell the stock after hearing you speak the pros and cons about the company. Also ask him whether he will buy the stock after hearing you out. This way you can expect to get a realistic picture about your decision.
But mind you, as I just said, that other person has to be some who gives his views independently, and not with a view to have a good impression on you.
Another way – and this is something even Warren Buffett would suggest – is to write down in simple words your reason to buy a stock and the reasons you would sell it in the future.
So once you buy the stock and any of the ‘sell’ reasons arrive, the written record will make it harder for you to pretend nothing has changed.
You see, fighting your own mind trying to get over your deep entrenched but wrong beliefs is a big challenge. In fact, it is a never ending battle.
But if you can’t conquer this bug of your own mind, you do not stand a chance of outwitting the market into becoming a successful investor…ever!