Biases Investors Should Be Wary Of

Photo by Hal Gatewood on Unsplash

Be fearful when others are greedy and greedy when others are fearful.
Warren Buffett

Most investors lose money in the stock market because of cognitive biases.

Wikipedia defines a cognitive bias as “a systematic pattern of deviation from norm or rationality in judgment.”

Cognitive biases happen because we don’t perceive the world objectively; we perceive it with a lot of preconceived ideas and patterns that do not necessarily exist.

As a result, our perception of reality is skewed, so we make mistakes about the world.

Find below 7 biases you should be aware of when investing.

1. Loss Aversion

Loss aversion is a cognitive bias identified by two Israeli-American psychologists called Amos Tversky and Daniel Kahneman (Kahneman subsequently wrote Thinking Fast and Slow where he tells the story of discovering dozens of biases).

Loss aversion explains we experience more displeasure losing, say, €100 than we would experience satisfaction earning €100.

Practically, it means that people will be more likely to act to avoid losing something than they will be likely to act to earn the equivalent.

How does it translate to investing?

In the refusal to sell. You may make a dubious investment with no future prospect and by the time you realize it, you’ve already lost a considerable amount of money.

Loss aversion will make it difficult for you to sell the investment because “it may always go up”.

Likewise, you may strongly hesitate to invest in a stock that could be a great investment because you’re afraid to lose your money.

2. Confirmation Bias

Confirmation bias is a cognitive bias explaining how we seek information that confirms our views instead of seeking objective information.

If you invest in, say, Bitcoin, you are likely to subsequently read articles praising Bitcoin investment to make yourself feel good about it.

And you are as likely to discard information that discourages people to invest in Bitcoin.

This is dangerous since it prevents you from having an objective opinion about the investment you have made.

If the investment you’ve made is a genuinely good investment, you’re in luck. Confirmation bias won’t negatively impact you.

Confirmation bias is one of the most prevalent biases in the world of investing. The truth is that we are not good at being objective about our own actions or opinion.

We don’t choose our opinion based on information. We seek information that explains our opinion is a “good one”.

Confirmation bias is dangerous because it can lead you to be pessimistic where you should be optimistic, and optimistic where you should be pessimistic.

To fight this bias, make sure you read material that discourages investment in the assets you have invested in. You will be more likely to have an objective opinion this way.

3. Incentive-caused Bias

Incentive-caused bias explains how people are easily motivated to do something when they’re rewarded for doing it.

Let’s take the Tesla stock as an example. Tesla has several times been on a bull run that saw it gain several percentages per day.

Investors that held Tesla during the bull runs were rewarded every day for doing so.

But when the stock began to tank, they didn’t sell because they had been rewarded for keeping the stock.

This bias is a dangerous bias because it compels you to keep on doing something even though that thing may be doing you wrong in the long term.

One of the ways to fight back against the bias is to wonder: if the incentive wasn’t there, would you still hold the investment?

4. Hindsight Bias

Hindsight bias happens when we look at past events we could not predict at the time and still say “it was predictable, I knew it all along”.

Doing so, we believe we’re better than we actually are at predicting something which gives us a sense of false confidence as we’re about to make investment decisions.

Investors can fight back against the hindsight bias by keeping an investment journal where they write why they made the decision to invest when they did, and what they thought would happen.

This journal appears to be a more reliable version of the past than our memory and can operate against hindsight bias.

5. Groupthink

Groupthink, also called herd mentality, is a bias that strongly incentivises us to do “like everyone else” without giving more thought to what everyone else is doing.

Groupthink is why bubbles in the financial market happen. Investors invest in a stock because other investors invested, and that compels other investors to invest.

Obviously, it’s a very dangerous bias because an investment opportunity should never be studied in light of who invests in it.

It should be studied in light of its basic economics.

6. Anchoring Bias

Anchoring bias describes the phenomenon of relying too much on one metric or variable that worked in a past investment.

These can be the time of the year, the time of the day, etc. Nassim Taleb told a story of how he unconsciously hailed a cab at the same place he had gotten one the day before, day which had been particularly profitable.

There isn’t much to do against the anchoring bias, as humans are superstitious by nature. You can always create an investment checklist that will help you make sure you’ve made an “objective” decision.

7. Chasing Trends

Chasing trends is the last bias on our list.

This bias is akin to the groupthink bias. Some investors will solely invest in trendy businesses, be it web3, crypto, meatless meat, etc.

This is a very dangerous bias (and investment strategy) as it’s difficult to differentiate trends from fads, especially in the early days.

Investors should aim to spread their portfolio when investing in trends in order to decrease the risks.

They should also consider other factors rather than just the fact that “everyone is speaking about it” before investing.

Conclusion

Investing is very easy. Buy low, sell high.

The problem is that this principle goes against our natural tendencies to do things.

Our biases make us buy high and sell low instead.

When you understand your behavior and your own nature, you can prepare and act in a way that decreases your chances to make an irrational decision.

The best investors are those who manage to leave their emotions at home.

Easier said than done.

One of the ways to decrease the risk of making an investment mistake is to invest in an asset with low volatility. When your asset gently and quietly increases regularly, it doesn’t test your emotions like highly volatile assets do.

Farmland is one of the least volatile assets in the world, and appreciates by 10% per year on average.

Begin your farmland investment journey on landex.ai today.

The content of LandEx’s blog is for informational purposes only, you should not construe any such information or other material as investment, financial, or other advice. Nothing contained on the LandEx Medium blog constitutes a solicitation, recommendation, endorsement, or offer by LandEx or any third-party service provider to buy or sell any financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.

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LandEx is the first European investment platform enabling any EU retail investors to invest in farmland. Find out more at https://landex.ai