Jeff Miller | Oct 19, 2016 02:51AM ET
Most thoughtful investors know and understand the concept of confirmation bias. Very briefly put, we selectively perceive and choose evidence that supports our existing beliefs. It is a powerful natural process. Everyone is susceptible.
Morgan Housel has a good challenge: “What’s something you strongly believe that’s likely wrong?” He has a wonderful description of the key problem:
And while most of us are OK being told we don’t know everything, being told we have a lazy thought process is hard to interpret as anything but an insult.
So we have the ultimate cognitive dissonance: Fully aware that we’re wrong about something but unable to admit being wrong about anything.
Unfortunately for the decision maker, fixing the process is the key to better results. There are various discussions about how to avoid confirmation bias, but they are pretty general and not well-linked to investment decisions. Even worse, many investment discussions descend into an argument about who is biased, instead of an intelligent discussion of the facts.
Since it is not easy to detect your own biases, I have devised a Confirmation Bias Quotient to help. I have scaled the test so that high is good.
If you are really mired in bias, you could have a score of negative 15 at this point. Let us turn to the positive factors. Each is worth a possible +5 points, for a total of +20.
The Test is one of Process, not Conclusions
A crucial point: You may well reach a consistent bearish or bullish conclusion without significant confirmation bias. The test is about your information, method, and process — not about conclusions. Different experts can look at the same data and reach different conclusions. In my weekly WTWA column I carefully follow all four of the positive factors listed, and strive to maintain a high CB quotient. It happens that my conclusions have been correctly bullish. Some erroneously believe that this reflects bias. Not so. If the evidence changes, so will my conclusions. Why shift from a winning method for “cosmetic” reasons?
Scoring the Test
If your score is negative, your biases are costing you money. My estimate is that 70% of investors would have a negative score on this test.
If you have even a small positive score you are actively seeking objectivity – probably in the top 20% of all investors.
If your score is above +10, you are doing a very good job of seeking evidence. Your investment results probably reflect this!
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.