FOR BEGINNERS (PART VII)

II. c) Psychological Misjudgments (Continued)

You can find List I – Here.

List II

1. Direction of Comparison. When people view a decision as one of preference, they tend to focus on positive qualities. In contrast, when asked to sell stocks, people tend to focus more on the negative qualities of each option. It is a good idea to go through your stock portfolio routinely and compare holdings to each other and to potential new ones via buying / selling lenses.

2. Extremeness Aversion. Scientifically, this refers to context of choice (and is complemented with tradeoff contrast). In practice, when you have 2 phones to choose from with price tags of $200 and $300, the distribution is approximately 50/50. However, when you add the third option with a price of $500, $300 phone wins by a wide margin (2 to 1 against the cheapest one).

3. Preferential Bias. Once people develop preferences, even small ones, they tend to view information in such a way that it supports those preferences. Everybody heard of the first impression and brand loyalty. It can become very costly. Saying is, that people hear what they want to hear.

4. Anchoring. There is a tendency we all have of latching onto an idea or fact and using it as a reference point for future decisions. Those facts can be completely irrelevant as experiments linked personal code last 2 numbers to the price one is willing to pay for a chocolate. People with high numbers overbid 60-120% those with smaller numbers. Anchors could be previous stock price, price estimate or price trend.

5. Confirmation Bias. People are almost 2 times more likely to select information confirming rather than disconfirming their prior beliefs and behaviors. Defensiveness overweight desire for accuracy in driving a preference for confirming over disconfirming information. Such cognitive dissonance leads to rejecting new facts that are contrary to original investment thesis.

6. Rationalizing. Tendency to rationalize leads to explain by an apparently rational story: a) whatever action, even irrelevant; b) whatever event, even of unclear origin; c) whatever possible sources of responsibility (external – negatives, self attribution – positives). Everyday media finds good explanations of why market went down or up. Truth is that nobody knows the truth – we can just guess.