If you’ve ever had the feeling that the stock market is rigged, perhaps it’s your own brain playing tricks on you. Humans have the most highly-evolved brain of any species on the planet, but sometimes our way of thinking can produce biases that we aren’t even aware of.
Credit Suisse analyst Michael Mauboussin recently looked at four psychological biases that consistently hurt investment returns.
1. Social Conformity
The idea of social conformity makes sense in certain contexts. It makes sense to emulate the behavior of others when they are more knowledgeable or skilled than you are.
There is also an inherent safety in doing what everyone else is doing. However, while it might make you feel good to buy the same popular stocks as everyone else, those types of stocks typically do not outperform the market.
When it comes to conformity in investing, Mauboussin quotes Benjamin Graham, “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”
2. Pattern Seeking
Humans are predisposed to identify patterns, and this ability often makes our lives much easier. However, our ability to find patterns can sometimes cause us problems when there are no true patterns to be found.
The perception of patterns when no patterns actually exist is referred to by statisticians as a Type I error. In the stock market, the clearest example of this type of behavior is believing that past price performance is predictive of future price performance.
While there may be some value in technical analysis of stock charts, the idea that a stock is a good stock to buy now because it was a good stock to buy last year and the year before can be a costly (and incorrect) assumption.
3. Hyperbolic Discounting
This bias has…
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