Posts filed under “Psychology”
A Simple Strategy for Shaking Confirmation Bias
Brett N. Steenbarger, Ph.D.
One of the most insidious cognitive biases affecting investors and traders is confirmation bias. Once we hold a particular view, we tend to prefer processing information that fits with that view. What’s worse is that, because of our bias blind spots, we commonly recognize biased thinking in others, but not in ourselves. We know from research in psychology that fresh inputs and mental flexibility are essential to creativity of thought. When we become locked in confirmation bias, we cease to innovate.
So how is one to overcome not only confirmation bias, but our own bias blind spots? One way is to develop the discipline of reading articles and posts that have been selected for their quality by experienced, independent agents. This is why I make it a habit to read selections curated by Abnormal Returns and The Big Picture. At various times, the editors of those blogs, Tadas Viskanta and Barry Ritholtz, have highlighted posts from my TraderFeed blog. It’s been my observation that, with rare exception, they have selected posts that I myself found to be among my more informative offerings. By delegating information curation to multiple independent parties with demonstrated domain knowledge and critical ability, I ensure that what I read is not a mere reflection of what I believe. Long-time readers will recall the curated links of Charles Kirk, who now offers those to traders he mentors through his site. This is a dynamic I have noticed in medical education: part of teaching is directing trainees to quality information sources—and helping them distinguish high quality material from the wealth of verbiage out in the world.
A second information source I use to ensure a fresh flow of quality material is SSRN, the Social Science Research Network. This is quite possibly the greatest treasure trove of free, high quality information that investors don’t know about. Interested in cognitive science, economics, entrepreneurship, finance, innovation, or leadership? SSRN is a repository of journal abstracts and scholarly papers from leading researchers around the world. Here the peer review system—and the quality of the authors’ published works and academic affiliations—help to ensure high quality among the readings. One SSRN feature I particularly like occurs when you download a paper: links appear for related papers that have been downloaded by those accessing the original manuscript. It’s a great way to quickly survey relevant, high quality research on a topic.
So, for example, I recently scoured SSRN and came across a provocative paper on Factor Investing by Andrew Ang. Drawing upon his experience working with Norway’s sovereign wealth fund, Ang documents how the lion’s share of investor returns come, not from timing and active management, but from asset allocation. How did I find Ang’s work? It popped up as a link when I checked out a work by Marcos Lopez de Prado on what to look for in properly and improperly constructed backtests of ideas in finance. And, yes, alas, it turns out that a system I had developed to trade the S&P 500 Index qualifies as overfit by the criteria of that article. There aren’t many better challenges to confirmation bias than that!
We are properly discerning about the food we put into our mouths, but not so much with the information we choose to process. Fresh inputs, chosen for their quality, provide a healthy intellectual diet and catalyze creative thinking. If we’re not regularly surprised by what we read and discuss, the odds are good that our brain’s diet has turned stale. And that’s a danger zone for confirmation bias.
Brett N. Steenbarger, Ph.D. is Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and works as a performance coach for hedge funds, proprietary trading firms, and investment banks. He is the author of the TraderFeed blog and several books on trading psychology.
Lately, I have been hear an interesting type of argument. It is a form of debate that is both disingenuous and dishonest. We will call this the “Can’t Lose Argument,” or CLA. Worse than confirmation bias, it is a money-losing exercise in narcissism. The CLA goes something like this: A data point will be mentioned,…Read More
Regular readers know I enjoy discussing behavioral aspects of investing. The reasons for this are twofold: First, we can’t control the markets, but we can control our own reactions to it (at least we can try). And second, many studies have shown that investors suffer from a behavior gap between what they should garner in…Read More
During the past few months, we have posted a few words here on the quandary that is hedge funds. One such effort was titled “The Hedge-Fund Manager Dilemma,” and it explored the public’s fascination with the hedge-fund crowd. The next, “Why Investors Love Hedge Funds,” looked at why, despite stunning underperformance during the past decade,…Read More
Rob Arnott turned the world of passive index investing upside down. Best known for creating “smart beta,” Arnott creates models weighted b y four factors: Sales, profits, book value and dividends. Market cap is not relevant to him. Funds running Arnott’s models manage about $200 billion dollars in smart-beta strategies. Assets have increased by 59…Read More
Nicholas Epley is the John T. Keller Professor of Behavioral Science at the University of Chicago Booth School of Business. He was named a “professor to watch” by the Financial Times, is the winner of the 2008 Theoretical Innovation Prize from the Society for Personality and Social Psychology, and was awarded the 2011 Distinguished Scientific…Read More
When was the last time anyone got good investing advice from the front page of a newspaper or magazine or from a television pundit? That is the question I have been pondering during this market cycle. Whether it is the price of equities or the state of the economy, I have grave reservations about relying…Read More
Things to try in a market correction: • Respond emotionally, giving in to your lizard brain. It does a good job of keeping you alive, so you might as well hand over management of your portfolio to it. • Rely on your gut instinct to lead you out of trouble. After all, your instincts helped…Read More