Knowing our biases can help us become better investors. So what are yours?
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Confirmation bias
The confirmation bias refers to the phenomenon of seeking selective information to support one’s own opinions or to interpret the facts in a way that suits our own world view. Investors seek confirmation for their assumptions. They avoid critical opinions and reports, reading only those articles that put the point of view in a positive light. -
Availability/Attention bias
The attention bias states that things such as products, companies, and issuers that are more frequently present in the media will be remembered more quickly by investors when they look for a suitable investment instrument.
Bad or scarcely accessible information is (unconsciously) not considered. -
Home bias
Statistics show that most investors tend to buy stocks from companies in their home country. These stocks seem more trustworthy, and investors grew up with these company names. They are also mentioned more frequently in the local media. -
Favorite long-short bias
People who fall into this psychological trap always bet on the long shot, because it promises very high returns. Unfortunately, they forget that the likelihood of the long shot winning cancels out the profit in the middle. -
Anchoring
When making decisions, investors do not rely on fundamental factors. Rather, they tend to base their decision on the price at which the original or last position in a stock was purchased. This purchase price is the anchor and causes irrational decisions. Unlike the acquisition cost, the new price seems cheap to the investor. Anchoring influences individual decisions based on the fact that investors do not realize how the information is presented. When it comes to making decisions, people seem to be influenced by random data, even if they know that the data has no informational value or is outrageously high or low. -
Myopic loss aversion
Most investors fear losses more than they enjoy profits. If these investors look at their stock performance too often, they usually see they have lost money and sell everything off again. A long-term view would be better. They should check their stock performance less often. The more they can keep their curiosity at bay, the more likely they are to turn a profit with their investments, provided that the portfolio is broadly diversified. -
Mental accounting
Many private investors engage in mental accounting, i.e., they make distinctions in their head that do not exist financially. Often, losses incurred are viewed separately from paper losses. This means that people sell stocks from their portfolio too soon when they make a profit and too late when they make a loss. So mental accounting makes us think that
a franc is not worth a franc – a dangerous attitude. -
Disposition effect
Gains are realized too early and losses too late as a result. Turning a paper profit into real profits makes us happy, while we shy away from turning a paper loss into a real loss. One possible explanation is mental accounting (see above). -
Overconfidence
In most cases, we overestimate our own abilities and think we are above average. Notably, most experts also overestimate themselves – frequently to a greater degree than laypersons do. Overconfidence is often seen when the markets are on the rise. -
Hindsight bias
The statement “I knew the whole time this would happen” shows that hindsight is 20/20 and that we have an explanation for everything after the fact. This is known as the hindsight bias, which is a problem because it keeps us from learning from our mistakes. -
Get-even-itis
Once we have lost money we take a greater risk to make up for it. Get-even-itis can cause us to place everything in one basket and probably lose even more money. -
Representativeness bias
After even a brief period of positive returns on the financial markets, we may think the world has changed for the better. People tend to think in schemes and stereotypes learned in the past. They arrive at a result too quickly and based on imprecise information. -
Gambler’s fallacy
Here, the effective probabilities are greatly underestimated or overestimated. This can mean that, based on the (false) assumption that prices are about to drop, we sell too soon and vice versa (assumption that the prices will recover soon, even though they are not (yet) doing so). -
Framing bias
Decisions are based largely on how facts are depicted in statistical terms. For instance, we do not think that “Four out of ten are winners” and “Six out of ten are losers” mean the same thing. The statement is identical, but most people don’t realize it. -
Regret avoidance
If we invest in a blue chip stock and it does not perform as hoped, we call this bad luck. However, if we invest in a niche product that fails to perform well, we tend to regret this more than we do the failure of the blue chip stock. This is because many other people have made the same mistake and thus our decision to buy it does not seem so wrong.
Source: https://www.credit-suisse.com/media/assets/private-banking/docs/mx/wp-07-behavioral-finance-en.pdf
Actually, the more you do, the more you lose.