The basic idea of “confirmation bias” is; we hear or see what we want to hear or see. The phenomenon does not imply stupidity or laziness, in fact, it is quite the contrary. Confirmation bias occurs when we want something to be true and so we seek out the research and evidence that supports our belief.
Although the evidence that we use to support our conclusions may be true, the problem with confirmation bias is:
- That the evidence we gather to support our belief is usually true [and]
- It is a “bias” because the information is incomplete or one-sided.
- As a result of our bias, we come to a conclusion that confirms what we wanted the outcome to be from the start.
That’s the bias of our conclusion, it confirms our original belief, or more accurately sometimes, our “hope.”
This phenomenon probably sounds familiar, as it should. We are all guilty of confirmation bias.
Confirmation bias not only occurs on a daily basis, from what food we believe is nutritious, or what party we decide to vote for in the upcoming election. Confirmation bias also occurs when we invest our money.
Biases in Investment Strategies
Investment strategies are no stranger to confirmation bias. This is in part because we are trained by our past rewards. That is, if a stock has been successful in the past, we believe that the same will be true in the future.
And this is often the case; the market is like a living organism, and as such it has ebbs and flows. Dips in the value of Google, Amazon, and Bitcoin are not necessarily a sign that these assets are failing. What they more likely demonstrate the changes in investors’ perceptions, and what consumers want from these companies. Markets are never stagnant.
This is an important fact to remember about the behavior of the market. However, it is also important to remind yourself of the qualities and reasons that make an asset valuable.
Assets are valuable because they are exchanged as currency, such as Bitcoin or because the company is valuable. Or if its real estate, it is valuable because of the location, and the fact that everyone needs a place to live.
But if you learn that your Hawaiian pied-à-terre is at the base of a volcano, do not expect the value to increase. Just as I hope you no longer hope you can retire on your beanie baby collection. Sometimes you need to let go of a belief, even when it was reasonably founded.
The same goes for your investments, just because a company performed well in the past, does not mean that it will do the same in the future. This is where our research and bias occurs. If you have holdings of an asset, you likely want to believe that it will recover when they begin to drop.
You’ve invested in an asset, and maybe even already benefited from that asset’s value. And because you want your valuable stock to recover, you look for evidence to support that it will continue to perform well.
A Closer Look At Confirmation Bias
Psychologist and cognitive scientists developed the concept of confirmation bias. Confirmation bias is the tendency to seek out or interpret information to support your current or desired beliefs. The predicament that this phenomenon causes, is that you are biased because your information selection is limited. As a result of the bias, the information you’ve collected leads you to an incorrect outcome.
You can also think of confirmation bias as a form of inductive reasoning. Inductive reasoning is basically focussing on a specific event and then applying the outcome of that event to a generalized principle.
Inductive reasoning is the opposite in deductive reasoning. Deductive reasoning involves moving from a large amount of general information to a specific conclusion. This is usually a more reliable way to form beliefs because there is a larger information selection.
The important difference between the two is that deductive reason is collecting a large amount of information in order to correct for outliers and biases. We cannot form sound principles or generalities from one-off events. You need to have more and balanced evidence.
The other sticky thing about confirmation bias is that we are not performing good, rigorous scientific work. And this is because we are compiling information to conform to the hypothesis that we hope will be correct, based on a belief we previously formed.
You can also think of confirmation bias as a form of “selection bias” where we collect only evidence that confirms our belief of hypothesis. Now, it is ok to have a hypothesis, but if your evidence and the outcome of your research points to new information, we have to reformulate or even abandon our earlier belief, or even “hope.”
Now let’s say that you did your homework, you’ve collected the evidence, but the result is ambiguous. Your pros and cons list is the same length. Or there are many uncertain variables and outcomes that seem to discredit some of your certainties.
Or, perhaps your personal experiences in life have taught you that despite the evidence, a certain outcome is more likely to happen. People do win the lottery and people get hit by lightning; so why not buy a lottery ticket?!
What you have done in this case is under weigh the evidence contradicting your belief. And therein lies the bias. Because you have equal or nearly equal evidence to support your earlier view, instead of changing your mind, or opening yourself up to the dubious world of skepticism, you go with your gut and bet on yourself.
Blame it on Evolution
There are some studies that suggest that one of the responsible factors is that our behavior is trained by reward. It is the classical Pavlovian response to positive and negative reinforcement.
What is interesting about confirmation bias is that it is a kind of irrational decision making. The rub is, however, that you believe you are being rational. You did your homework after all!
But it is entirely possible that such irrational or mediocre research is part of our evolutionary heritage. That is, we might be privileging our “adaptive” nature over rational decision making.
It may have been more advantageous for our evolutionary ancestors to use the most valuable alternative first. What that means, is that instead of looking for the “best” way to do something, we simply choose the next best option, that is readily available.
Optimism and Reward in the Bias
In this study, it demonstrates that people were more biased towards an action that would yield a reward.
Reward-based behavior may have offered us some kind of evolutionary boon. In the example from the study, if the decision is to leave or stay in an area to find food, the most valuable thing to do might be the first thing you do -namely, find food quickly.
This does not assume that the food source found is the most nutritious, or the more reliable. It simply suggests that these are short-term goals, based on necessity, and not rationality.
It is possible then that necessity biases information sampling, which leads us to make suboptimal decisions, using incomplete data.
This all sounds a bit like fancy talk for the old maxim “better the devil you know.” But we are creatures of habit. And these are not always the best habits, just habits that have served us in the past.
Perhaps the important take away is that our evolutionary ancestors did not have the luxury of time and patience. They were too busy running from saber-toothed-tigers. Modern humans, on the other hand, have all kinds of time, and information readily available via the world-wide-web.
However, just because we can do better, does not mean it is easy to do better. Overcoming confirmation bias may require diligent training and effort. One of the challenges, maybe, is to appropriately manage instant gratification. If we do not need to be rewarded immediately, then we might stop and look at the evidence more critically and clearly.
The Bias In Investing
As I mentioned at the start, this behavior has an effect on the way we make investment decisions, as much as any other decision. If we are poised to be rewarded for our past investment savvy, then it is unlikely that we will second guess ourselves and our information sources.
Scenario: You’ve been thinking about investing in a new asset and so you begin the research. As you research, you get caught up in all of the gains that others have made. Then you begin to compare it to the other similar assets you have invested in successfully.
Then, you begin to delve into the chats, blogs, and tweets about asset X -and everybody’s got an opinion! The more time you spend investigating other holders, the more you begin to think like them and form your belief about asset X.
You start to build a bias because you are in fact a smart, experienced investor.
Managing the Noise
The same phenomenon occurs in traditional investing as well as in the cryptocurrency space. Especially after you have done the research and you believe you understand why your new favorite token is doing well.
The catch is that now you are a part of a social circle of like-minded people who all believe the same thing. And you have all invested your time and money into this project.
Then! Woe of all woes! Your token starts to behave poorly. But instead of asking why it is doing this, you hold on to the better days, when you and your twitter followers touted the gains you all made.
This is the challenge of any investment and cryptocurrencies and digital assets are no exception. The market does not act in a vacuum. There are many forces acting on the market which are of consequence.
And unfortunately, for all of the success of the crypto space, there have been just as many failures. Some of these are not failures, as they are ICO scams and the like. However, many well-intentioned and ambitious projects fail too. And when you are trying to start a project optimism pays off, new companies are not often willing to air their dirty laundry.
What Can You Do?
Amid the tears and recriminations, as an investor, you must look at the facts and ask yourself:
- How did the tokenomics work? What were the weaknesses?
- What kind of marketing strategy did they use? How far was their outreach?
These are also the kinds of questions you must ask of any project that you are interested in. Instead of just looking for the evidence that suggests it will succeed, look for the gaps, the unanswered questions, and the inadequacies.
Step away from your fellow investors. Once you are entrenched in the noise of the cheerleaders, your own skepticism is drowned out. Because when we hear information that does not gell with our belief about something, we dismiss it.
That’s right, we want good news and we want to be rewarded. Rather than hear the criticism we move on to the next cheerleader.
Learning from the Evidence
But if confirmation bias is in our genes, then how can we overcome the problem?
The answer is to think slowly. We do not have to make life or death decisions in an instant when we are considering investing in a new project.
Know that you need to make decisions slowly and work to keep an open mind. We all want to be rewarded. But the fact remains that this is not always the case. Own that fact, the more you learn to recognize your missed steps the better you will become at investing wisely.
Steps to Combating Cognitive Bias
- Admit that you were wrong: It does not matter that you had a good plan, the fact is that you made a poor decision. Take responsibility for your missed steps and take note of them. We can learn from our mistakes.
- Do your own research first, socialize later: When you are starting your research, start with the facts. Look at the numbers, learn how the company is performing. Then ask yourself, what need is this project is filling? Leave social media for a later date. Decide what you think based on what you’ve learned. Then enter the social realm and see what others are saying on both sides.
- Build your case with facts, not with opinions: Where are you getting your information from? Other holders and the project creators are going to have a particularly optimistic perspective on the project. That may be just fine, but if you did your own research in step 2, then you will have facts to support or refute these opinions. Form a well-rounded opinion that acknowledges its weaknesses, not just its strengths.
- Keep an open mind, resist the bias: Remain neutral and objective for as long as possible, and return to the space of being open-minded. To do this you need to be skeptical, and ask yourself: what are the problems I am overlooking? Be critical, if the project sounds too good to be true, it probably is.
Investing is a calculated risk. Do the calculations and let your head do the heavy lifting, rather than your gut, or your instincts.
And remember, it is ok to be wrong. If you are able to acknowledge your confirmation biases then they will not have as much effect on you when trying to make objective decisions about your future investments.