Thursday, March 07, 2013

Confirmation Bias Dangers And Apple

One of the most damaging psychological phenomenons for investors is confirmation bias. In the world of science confirmation bias is most commonly defined as:
"A phenomenon wherein decision makers have been shown to actively seek out and assign more weight to evidence that confirms their hypothesis, and ignore or underweigh evidence that could disconfirm their hypothesis (ScienceDaily)."
The excellent website, Abnormal Returns, recently highlighted how investors have been harmed by the recent price action of Apple (AAPL), much of the harm attributable to confirmation bias. Two of the articles Abnormal Returns references focuses on the role greed plays in confirming the validity of the confirmation bias phenomenon.
  • The Rise and Fall of Andy Zaky: Apple 2.0. In this Fortune magazine article, the story describes how investors recently made increasingly risky bets on Apple convinced that Apple stock was only going to move higher. The result has been investors have lost millions of dollars on their wrong "bets".
  • Greed + Confirmation Bias = Disaster. This article provides some insight on what investors should do in order to minimize the negative impact of confirmation bias. The article's main summary for investors in order to avoid confirmation bias is:
"When you’re in a trade or an investment, you should be more eager to hear from the people who disagree with your thesis than from the people who agree with your thesis."

For investors then, seeking out views the are contrary to ones investment bias is usually an important strategy that can lead one to avoiding substantial investment losses.

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