It is indeed true that letting go of your emotions while investing and relying entirely on rational decisions. We hesitate to accept the fact that our human brains even prompt us to take wrong decisions at times, especially with regards to investment. As long as reasoning, critical thoughts, strategizing and comprehension capabilities are concerned; the human brain can easily handle enough capacity.
But from the biological perspective, the human brain is limited by its physical size. As there is a restraint on how much information the brain can process and store, human beings have automatically developed few cognitive shortcuts which help them. In fact, it is through these cognitive shortcuts that our ancestors have conquered the world. But that doesn’t mean that they’re always bound to prompt the right step. They can also make us commit few costly investment mistakes. Let’s check them out.
Bias based on representation
This is a mental shortcut which is utilized by humans when they tackle large amounts of information. Rather than analyzing different things individually, we try to group them or categorize them and end up with generalizations. While this can still work in daily life decisions but when it comes to investing, this can lead to a big mistake. The devil resides in the details. When it comes to stock investment, there are clear differences among companies even when they happen to be direct competitors. Even companies which seem to be identical can have disparate results
Bias based on anchoring
Often it is seen that the first impressions or first experiences of an investor with some company stock is tough to shake. If the experience and impression has been negative, this opinion is tough to shake. For instance, if a person buys some stock and witnesses gains of 25% within the next 6 months, he tends to view this stock as a winner even if it drops in price. You should avoid riding your winners for too long time and avert being partial towards a losing position. You can fight against anchoring bias by getting in touch with a professional who can offer you a neutral third-party opinion.
Bias based on confirmation
This is ethically related to stubbornness. Once we successfully form an opinion on some stock, we usually tend to watch out for information which supports our belief. In fact we tend to ignore anything that is in conflict with it. Confirmation bias is the main reason behind parents always believing that their son or daughter is the smartest kid or the best player. They tend to see everything good in their child. So, ignore all shortcomings and pay attention to the accomplishments of your child. Investors should also have a similar attitude towards stocks and investment.
Although it is tough to get over with tendencies which are hard-wired but you should always try your best to stay away from all such biases. Try and take influential decisions while investing so that you don’t suffer from huge losses in the long run.