Decision-making skills are one of the most important skills a man should possess. While making any decision, two parts of our brain are set to work. One system lets say, System A, which is a bit shorter path containing more of emotional weigh less of logic. System A is preset so the brain need not work hard to generate it, less work to do. And there is another system lets call it System B which is relatively lengthier one, takes time to do work for the brain, takes up the rationalistic approach with logical touch. In some hot states, our mind resist to do work which takes time and effort, guess what? It prefers system A with less thinking and efforts. Of course, as per ideality, it is the system B which has to be efficient every time while decision making has to be done. To make this happen, we need to train our brain regularly to become patient enough and be smart at the same time. Some decisions have to taken(or are done) in nanoseconds. Let us take up an example, there is a snake inside a glass box(transparent from outside). A person peeps in, approaching the box, the snake immediately jumps from place to bite the person. His sudden reason would probably be a shock on his face and getting away from the box – because unconscious and fast decisions are usually made using System A!
Things go hand-in-hand in the case of Investing too. There are many psychological aspects to investment which every investor should be aware of before investing. We try to use our system A when we are in the hot state, usually when there is a lot of selling/buying pressure on the investor/trader.
Mastering yourself and your emotion is the key so that it won’t take away your decision-making opportunities during each such hot state. Just make sure you have enough practice using system B over system B and can stay calm!
Here we explain the top 4 common biases which happen with most of us during most of the time:
We always take up things by having a preconceived opinion in hand. We fix our mind or rather convince our self that this is the thing even if it’s not get confirmed. So while executing the process will look for that particular pattern to happen so that we are right. In the meanwhile, we actually ignore the information which needs to be seen. We make such pre-decisions on the basis of our past experience or others opinion. In investing, before indulging with any share we make certain information to influence us and we assume that it is and must be true which becomes the reason for the rise or fall of the stock. We realize later that we were wrong and regret.
They are various news channels, news articles, social media pages which announce various rumors and we get into confirmation bias while investing the next day morning.
Regret aversion bias
Humans are made in such a way that they feel the pain of loss more than the joy of gains. Whenever in our life the encounter a particular type of situation which we have already experienced in the past we are in a feeling that they may have a bad experience as they had in the past. This thought itself ruins the game. We destroy ourselves. In investing, we don’t remember the years we made more than 50-60% gains but we will definitely remember the few months of 22-30% losses. This feeling makes us upset when the shares, we invested after even rigorous research and analysis work, starts to slump. We feel at some to accept the loss happened till now without experiencing furthermore losses. This is regret aversion bias.
Assuming things and taking concrete decisions. ” I am very confident that this *will definitely* happen”, we make such statements very commonly based on various irrational factors.
Some examples that showcase the hindsight bias are:
A person looks outside the window, sees the gray and dim environment. He predicts that it will rain. Suppose it rains he then affirms that he was certain about the rain to roll in.
A person sends an article to the newspaper office. He is pretty sure that the editor will select it. Fortunately, his article gets selected and he claims that he was well ceratin about this.
A person has an examination today. He wears a red t-shirt as he is sure that the test will be hence easy for him. Suppose his test paper comes out to be easy for him. He will say that he knew that this will happen
In a similar fashion, Investors before investing they try to predict the future of that particular stock or Mr. Market and that suppose comes out to be true, then he will be pretty certain about these types of irrational approaches every next time and in one later point when the loss hits him his System A gets activated.
Recency bias is more about getting support for decision making from recent happenings perspective. We are traveling in a car, we see pass by some 10 bikes and 10 cars. Those 10 bikes either pass by in groups and within seconds while the cars come one by one slowly that we can clearly see even the people inside the car and the things there are carrying with them. Here, though the number of bikes and cars are the same, we come up to a conclusion that they were more cars than bikes, as the cars have hit their brain nerves very recently and frequently. This is recency bias.
In the market context, when the market index goes up we start to add in cash as we expect that the recent happening(rise) will sustain for more time. The similar thought process is applied when the market plummets, we feel it will keep on going the same way. Remember, whatever goes up surely has to come down one day and vice versa. Recency bias has to be taken significant care as it is very common among investors around the World.
To explore more about this stuff we recommend you to watch the movie – “12 Angry Men”. The movie is easily available on YouTube.