July 12, 2019
You’re Biased and it’s Impacting Your Trading
If there’s one thing that social media has helped to make painfully obvious, it’s just how biased people’s opinions can be.
I’m sure you’ve seen it. People are arguing about a political topic or their view on the markets and they’re ready to dismiss evidence just because it doesn’t fit their own narrative.
If someone is a Republican or a Liberal, they will stand firmly in that camp and not accept any of the points from the other side. Even the legitimate ones.
Likewise, if someone is long stocks, they’ll disregard all the doomsday perma-bears and just keep thinking stocks are on discount.
You see it in other people, but you probably don’t see it so much in yourself.
Blind Spot Bias
In fact, this phenomenon has a name. It’s called the Blind Spot Bias. This allows us to see the bias that other people have, but we struggle to see it in ourselves.
When we’re dealing in the markets, our biases can end up costing us money. If we’re not able to analyse a situation objectively, we’re going to end up skewing what the information is really showing us.
An intelligent investor or trader might hear that and think “yeah, but I take a neutral, emotionless view at the facts. I’m too smart to let my own opinions influence my trades over the data.”
While that may be true for a lot of people, it’s actually been found that the more intelligent you are the more susceptible you are to blind spot bias.
West, Meserve and Stanovich tested the blind spot bias in 2012 and found that a larger blind spot bias was associated with higher cognitive ability. The thinking is that the better you are at constructing a narrative that supports your beliefs, the more you can rationalise and frame the data to fit your argument or point of view.
It’s quite clear how this can affect people doing fundamental analysis since that will often involve political and economic factors, which people may have a bias towards. But it can actually happen with technical analysis too.
The Law of the Instrument
I think of this as being similar to the concept known as ‘The Law of the Instrument’, which can best be described by the expression “to a man with a hammer, everything looks like a nail”.
If you map a certain object on your charts, this will influence the way you observe the movements of the market. Someone using horizontal tools will see more ranges, while someone using trend lines might see a range as actually being a slight downtrend. They may even struggle to see when a sideways market is forming.
You might think that something looks obvious enough that everyone will see it exactly the same way, but time and time again this has proven to not be the case.
In 1951, the Dartmouth football team played Princeton in the last game of the season. It was a significant game for both teams and the event lived up to the occasion, in fact, it was a dirty and violent game, which Princeton ended up winning.
After the game, two psychologists used this to study how beliefs can completely change the way we process an experience that we’ve all gone through.
In their paper called “They Saw a Game”, they interviewed students from each school and found through their answers that it was as if they had watched two completely different games.
The psychologists concluded that:
“We do not simply ‘react to’ a happening… We behave according to what we bring to the occasion.”
This study was replicated in 2012, in a paper titled “They Saw a Protest”.
This time, two groups were shown the same footage of a protest that was being stopped by police but they were given two different reasons for the protest.
One group of people were told it was outside an abortion clinic and they were protesting against legalised abortion. The second group were told it was outside a college careers facility where the military was conducting interviews. They were protesting against the ban that was in place at the time prohibiting gay and lesbian people to be soldiers.
They were then asked about their opinion about how the protestors were treated by the police. As you may expect, the pre-existing beliefs people had about abortions or the rules of the military regarding gay and lesbian soldiers affected the way they perceived the situation.
Whether they sided with the protestors and saw their actions as being fine or sided with the police, their opinion aligned with their views on the topic being protested.
They all saw the same event, but their beliefs changed what they perceived to be taking place.
This is known as ‘motivated reasoning’ and it’s something that affects all of us. In fact, there’s a great documentary on Netflix called Behind the Curve that talks about Flat Earthers. You can see motivated reasoning in action when they try to explain why their failed experiments had the outcomes that they did.
This can also happen with situations when we are testing our trading systems or analysing a situation to justify a trade that we know deep down we really shouldn’t have taken.
It’s something that’s very difficult to overcome fully, but we need to do what we can to at least minimise the effects of it and have a more balanced view, particularly when looking at the markets.
The first thing we need to do is to keep a trading journal and analyse all trading situations from a neutral viewpoint, regardless of the outcome.
Next, if our analysis is based on fundamentals, we need to question the sources of our information. Most of us will look to news sources that align with our beliefs. If you’re more of a Republican or Conservative, you’re unlikely to want to spend your time reading Liberal publications. Likewise, on social media, you’ll probably be more interested in people with similar world-views to yourself.
However, this can lead to what Eli Pariser calls the ‘filter bubble’, as our own choices as well as algorithms from social media or other sites like Google, will lead you down the path of more and more information similar to that which you have already been consuming.
This is going to lead to you already having an unbalanced view on the world. Instead, it would be worth reading a mixed bunch of publications to start seeing things from other points of view. Rather than dismissing it all, try to think critically and objectively about what points actually make sense or not.
The next point goes for all types of analysis. We need to stop thinking that we are absolutely certain about things. Instead of thinking about what we are certain about, we need to think how certain we are. Maybe we are sure of something to a 70% certainty, or an 80% certainty. This leaves room for us to be wrong.
We can then start questioning our own analysis and information, or even getting someone else to question us. We can ask things like:
How do I know this?
Where did I get this information?
What is the quality of the information? Do I have enough information?
Are there any other possible alternatives that also make sense?
What beliefs did I have before this analysis or piece of information that may be influencing things?
Am I missing anything?
Ultimately, we can’t get rid of our biases completely, but by taking steps to try to see things more objectively, particularly when we’re going through the post-mortem with our trades. We will at least improve a bit more each time.