I like this article that’s been floating around on cognitive biases. As I liked to say, it’s in being wrong that we can learn to be right. Understanding your own failings through introspection is one of the best ways to learn. Understanding why we’re often inherently designed to fail at understanding certain things is a crucial stepping stone to cross over in this process.
Confirmation Bias – The tendency for people to favor information that confirms their beliefs or ideas. Investors and economists often fail to fully appreciate other views due to a narrow minded view of the world often resulting from what they think they already know.
Ingroup bias – the tendency to favor one’s own group. In investing and economics we see this in ideologies and particular strategies. Austrians favor those who believe their own thinking. Chartists dislike value investors. Often times, the strongest economists and investors are the ones who are able to move beyond this ingroup bias and explore the potential that other groups have something positive to contribute.
Gambler’s Fallacy - When an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events. We see this in trading all the time. This is the belief that just because something has occurred in the past that it is more likely to occur in the future. The “trend is your friend” and that sort of thing….
Post-Purchase Rationalization – When one rationalizes past purchases after the fact in an attempt to justify past actions. Investors often learn about how a bad trade turns into an investment when they rationalize their past purchases. If you’ve been in the business for a while you know how destructive this can be.
Neglecting Probability – A total disregard for probability and mismanagement of decision making through disregard for the odds of certain events. Investors and economists often overweight this in both directions at times ignoring the odds of a very high probability event and more often assuming that a high probability event (based on a small data set) means something is likely to occur.
Observational Selection Bias – An observational bias in which you begin to believe certain things are occurring more commonly because you’ve chosen to observe their existence.
Status-Quo Bias - The tendency to reject change in favor of what exists and feels comfortable in the present. This is a problem plaguing much of public policy. A staunch skepticism of change leads us to constantly believe that anything other than the status quo must be bad.
Negativity Bias – The tendency to focus on bad news as though it is more significant than good news. A problem rampant in the investment world. This is often the result of a lack of diversity in views and the inability to believe that past positions may or may not be wrong.
Bandwagon effect - the herding effect where we feel more comfortable doing what many other people are doing. There’s supposedly less risk in doing what many other people are doing even if they’re all engaging in the same irrational behavior.
Projection bias – the tendency to project your own feelings and beliefs to the rest of the world in an effort to confirm that your own views are accurate within the grand scheme of things.
Current Moment Bias - Focusing on the present to the detriment of the future.
Anchoring Effect - The tendency to focus too much on something first presented to you leading you to falsely perceive the value or significance of all other things around it. Amateur investors often do this by believing that the nominal price of a stock matters when compared to another stock.