Everyone in the trading world has his own biases. When make judgment about the markets and our analysis may often be subject to such biases. In general, there are two kinds of biases: cognitive and emotional.
In this article, we will tackle what these biases are and offer some examples for each.
What are Cognitive Biases?
Cognitive biases generally involve decision-making on established concepts, which may or may not be accurate. You can think of these as rules of thumb whose factuality or accuracy is questionable or maybe even totally flawed.
Confirmation bias is a cognitive bias that makes the investor put more emphasis or acceptance on data or opinions that confirms his or her predetermined belief.
Status Quo Bias
It’s quite natural for humans to resist the change spills over investment portfolios. The resistance is evident through the habit of coming back to the same stocks and funds instead of seeking out better plays.
Although investing in companies that already has your confidence is a good strategy, it’s also quite limiting when it comes to your ability to spot new opportunities.
This kind of bias is seen on investors who miss the bull market or great upward movements because of fear that it will soon reverse course.
To put it another way, risk averse bias makes investors put more weight on negative news than the good ones.
What are Emotional Biases?
Emotional biases occur randomly but based on the personal feelings of the individual investor at the time that he makes the decision. Most of the time, the biases are also deeply connected to the personal experience of the investor that influences his decision-making abilities.
These types of biases are usually ingrained in the psychology of the investors and they are also generally more difficult to overcome than cognitive biases.
It’s worth noting that emotional biases are not necessarily errors. In some cases, an investor’s emotional bias can help him be more prudent, careful, and protective of his investments. The following are the most common types of emotional biases.
Loss-aversion bias is when a trader or investor refuses to admit that he has made a bad investment decision by refusing to throw a losing investment into the garbage disposal.
They usually prefer to hope blindly that the losing investment will somehow reverse course and win. They choose that over admitting the it’s a lost cause and moving on.
An investor with the overconfidence bias typically believes that his investing skills are better than the next investor.
As everyone knows, overconfidence usually attract negative events. It makes the investor careless when it comes to his investing decision.
This bias is a tad similar to loss-aversion bias, in that it makes the investor value what he owns more than what he does not.
As a result, the investor tends to miss out of huge opportunities in other markets simply because he’s afraid to try to get what he doesn’t have yet.