Cognitive Bias
Lesson summary:
The lesson concept revolves around cognitive biases in motivated reasoning, including confirmation bias and motivated scepticism. Confirmation bias refers to the tendency to uncritically accept information that aligns with one’s pre-existing beliefs and scrutinise information that contradicts these beliefs. Motivated scepticism, on the other hand, involves applying more scepticism towards claims that oppose one’s preconceptions than those that support them.
An everyday example can be seen in how people consume news, especially regarding political or ideological issues. Someone with strong political beliefs may prefer a news outlet that shares their views, reinforcing their preconceptions. This person may uncritically accept the news from this outlet (confirmation bias) and be sceptical about the news from other sources that contradict their beliefs (motivated scepticism).
How Cognitive Bias applies to investing and trading:
In investing and trading, these cognitive biases can lead to potentially poor decisions. For instance, a trader may exhibit confirmation bias by uncritically accepting positive news about a company they favour, while overly scrutinising or dismissing negative news. Their motivated scepticism might lead them to doubt bearish predictions more than bullish ones if they are predisposed to believe the company’s stock will rise.
For example, an investor who has a long-term investment in a certain technology company may come across news of a potential scandal. Despite multiple reputable sources reporting on the issue, the investor might choose to believe a single report that denies the scandal due to their preference for the company’s success. This is a clear illustration of confirmation bias and motivated scepticism in action. It underlines the importance of objectivity in investment and trading decisions. To avoid these pitfalls, investors should strive to critically evaluate all information, regardless of whether it confirms or challenges their beliefs.