Yesterday, I wrote about what a cognitive bias is and listed six of them that can affect our psyche and the way we invest.  Today, I’ll go into detail on the first one: confirmation bias.  Confirmation bias describes our tendency to interpret information in a certain way to confirm what we already believe.  It also describes how we tend to avoid information that is not in line with our preconceptions.  One example of this deals with research and experimentation.  In an experiment, there is usually a hypothesis that describes what we think the result will be.  Sometimes, researchers will subconsciously frame their experiments to confirm that hypothesis.  Confirmation bias is of great interest not only in human behavior and psychology but also in other facets of study since it can really be linked to anything.

How can we relate confirmation bias to investing?  The common investor usually makes decisions driven by a mix of logic and reason as well as passion and emotion.  These emotions, whether positive or negative, fuel our biases for stocks, bonds and funds that we evaluate.  If an investor has a preconceived notion about a stock, they tend to seek information to validate that notion.  Burton Malkiel, author of A Random Walk Down Wall Street, describes this as “Castles in the Air”.  Investors sometimes dismiss the financial fundamentals of a company but rather fall in love with the company itself and the hype around it.  Sometimes I catch myself doing this without realizing it.  If I fall in love with a company’s products and hype (let’s say Apple [AAPL]), I find myself wanting to seek information to validate the company’s worth and dismiss information that disputes it.  We can fix this behavior by making an active effort to push personal biases aside in investing and making sound decisions from a financial and fundamental standpoint.  As investors become more experienced, it should become easier to accomplish this.  

Tomorrow…  Hindsight bias!