There are an extraordinarily large number of cognitive biases which change the way we think — it is important to know about these in stock markets both in order to look for them in one’s own thinking and expect them in that of other market participants
A Cognitive Bias is an element in our psychology which makes decisions for us. In fact, given there are so many of them, you might even say that our psychology is just Cognitive Biases. I discuss about 20 of them and give market context in my new book:
One example which I discussed in a previous post is Hindsight Bias. This makes us think that everything which has happened was inevitable. This in turn makes us very bad at knowing what level of probability we assigned to past events. We seem to remember that we said that a prior event was going to occur with 90% probability when in fact, we gave it a probability of 30% before that event occurred. This will obviously have unhelpful effects in the context of markets. It will make us greatly overestimate our chances of knowing what is going to happen next, which may make us trade with over-confidence. There is nothing quite like over-confidence to kill market performance.
As I said, the book covers around 20 biases and their effects in markets in much more detail than I can give above. The thing is though, that there are way more biases than that. In fact, from the chart below, which is due to Bence Nanay, you can see just how many there are.
Every one of these biases will affect your market thinking and that of everyone else involved. So it looks like we all have some work to do!
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