Introduction

Can you believe there is 5% of Americans believe in the Moon Landing in 1969 is faked, even today that multiple countries already had probes orbiting the moon? That’s about 16 million people who believe in this so-called conspiracy, but how do we know who is right and who is wrong? People who believe in conspiracy seem to always find some way to explain and justify their rightfulness, even though the evidence is against them. In fact, this phenomenon pertains to confirmation bias, a psychology theory that suggested people will seek relevant information to reinforce their cognitive and conversely block, disagree, or alter information that is against them. Confirmation bias can have far-reaching effects, impacting everything from the way people interact with others to the way they make decisions.

In this article, we’ll take a look at the confirmation bias in investment psychology and explore what are the causes and how it can impact investors. We’ll also offer some examples and guides to overcome confirmation bias when making investment decisions.

Definition of Confirmation Bias

Confirmation bias is a mental shortcut that has the tendency to search for, interpret, favour, and recall information in a way that confirms one's preexisting beliefs. it can be formed biased beliefs unconsciously through the influences from the surroundings, families and friends. Most people are unable to be aware they are biased until they discover the opposite, but it is not easy to accept the opposite standpoint as it challenges the current cognition.

Confirmation bias can further drill down into three types. First is biased attention, this happened when we selectively focus on information that confirms our views while ignoring or discounting data that doesn't. Second, is biased interpretation, which means we consciously interpret information in a way that confirms our beliefs. Third, another sub-category of confirmation bias is biased memory, which appeared when selectively remembering information that supports our views while forgetting or discounting information that doesn't.

Now you might ask, how do we know if we have confirmation bias? Here are some common examples of confirmation bias.

• When you are not seeking out objective facts and blindly believe what others say.
• When you are interpreting information to support your existing beliefs or perception.
• When you chose to remember the opinion that supports your belief.
• When you are ignoring information that was challenge your mind.

Why does Confirmation Bias Exist

Confirmation bias work naturally by our brain, it is not an ability acquired by learning but more towards like how a programme is designed to do so, in our case, human is designed to have confirmation bias to speed up the process of making a decision, especially during an emergency. When we are presented with new information, our natural tendency is to look for information that is able to confirm and supports our existing beliefs. This process is driven instinctive by our cognition, and it can have a significant effect on how we process information.

One of the explanations suggested the existence of confirmation bias is to help humans to increase the efficiency of information processing. In this complex world, we are forced to receive a myriad of information inflow day by day, but we don't have enough time to process each piece of information to form our own unbiased conclusion. Instead, our brains are hardwired to make quick decisions when we are exposed to new things, in order to differentiate whether the situation is safe or dangerous. Hence, quickly linking the new information we received and referring to the memory we have in the past, makes us roughly know and formed our belief toward the new information.

How Confirmation Bias can lead to Bad Investment Decisions

Warren Buffet, the legendary investor once said, “what the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.” It is certainly accurate in real life and especially true in the stock market as it can be explained by the effect of confirmation bias.

Investors can be easily trapped in confirmation bias, especially in the era of information. Most investors are instinctive to search for the positive sides when analysing a company but rarely do people search for the risks and issues encountered by a company. It seems to make sense to pour our time into searching the potentially positive news that could turn into a gain in monetary when we invest in it, the lure here is the potential upside of the stock price that we expect the market has not reflected it.

Although it is normal for investors to perform as such, if we are really in a neutral standpoint (biased-free), we should also seek the negative views of the company as it could trigger a fall in stock price that causes the investors in incurring losses. Hence, confirmation bias could lead to a bad investment decision when the investors only take the information from his favourable side to support their initial preference of the action. Especially when they are actively ignoring information that is against their action.

Examples of Confirmation Bias

One notable example of confirmation bias that people are still believing in is the multibillion-dollar homoeopathy industry. Homoeopathy was invented by Jacques Benveniste. He believes that as a solution of histamines was diluted, the effectiveness increased due to “water memories.” But the test results were performed without blinding, leading to a placebo effect.

Benveniste was so certain of his hypothesis that he purposely found data to confirm it and ignored that which did not. While other researchers repeated his experiments with appropriate blinding and found Benveniste’s results to have been false. As a result, many of the people who worked with him withdrew from science. Yet homoeopathy supporters have only grown in numbers. Supporters cling to any evidence to support homoeopathy while ignoring that which does not. As of today, many people still believe its works even though the first google search result tells us there is no scientifically plausible way that proves homoeopathy can prevent diseases.

Investment Examples of Confirmation Bias

The most common confirmation bias in investing is Investors tend to search for information that is favourable for them to digest and aligns with their initial preference. Let's say investors want to invest in a company because they saw a gap-up in its stock price and they expect the stock can rise further. And now there are two types of news related to the firm, one related to how management is trying to reduce its debts, and the other related news saying the company is stepping into bankruptcy. Hence, there are contradicting opinions from both sides.

Depending on the opinion one has framed with the initial encounter with the news, investors would interpret those opinions accordingly. As the investors intend to buy the stock due to the jump in stock price, they choose to believe the news that aligns with their action to back up their buying investment decision. Their action of purposely selecting information to neglect or accept triggers them to fall into the confirmation bias. Regardless of the result, the investors already set their minds on believing the news that supported them. In short, investors who are having confirmation bias will choose to blindly believe the stock will rise further based on their predetermined perception and support their belief with biased news that is favourable to them to make decisions.

Ways to Overcome Confirmation Bias

Confirmation bias is most likely to occur when we are gathering and interpreting the information needed to make decisions and it can also happen subconsciously. Most of the time, we are unaware of the influence of confirmation bias on our decision-making. Hence, the first step to overcoming confirmation bias is being aware of it. As confirmation bias is unavoidable, we have to always put ourselves in a neutral standpoint and try to capture the opinions from both regardless it is favourable or against our beliefs. Also, as confirmation bias is most likely to occur early in the decision-making process, we should always stick with factual bases and gradually build up our reasonings by considering all good and bad standpoints.

Another way of overcoming confirmation bias is always seeking sources from multiple parties. We should always listen to multiple news sources from different companies and countries to ensure the news we watched or listened to is not biased. This is crucial, especially in this information era, there is plenty of fake or unreliable news that appears easily on our devices that could manipulate our minds and action. Hence, cross-checking with various news sources is a practical step in an attempt to reduce our confirmation bias.

The Bottom Line

Confirmation bias explains why two people with opposing views on a topic can see the same evidence but have different interpretations. Each person is born and grows up in different environments, and hence the perceiving beliefs and perception towards an object or event are merely unable to escape from confirmation bias. To counterpart the confirmation bias, we can always ground up facts, and treat every piece of information with a neutral stance at first. Also, adopt scientific and logical reasoning steps to comprehend the information to ensure we are on the right track of reasoning.

At last, this article can provide an opportunity for you to assess how confirmation bias affects you. Consider looking back over the previous paragraphs and asking:

• Which parts did I automatically agree with?
• Which parts did I ignore or skim over without realizing?
• How did I react to the points which I agreed or disagreed with?
• Did this post confirm any ideas I already had? Why?
• What if I thought the opposite of those ideas?

Being cognizant of confirmation bias is not easy, but with practice, it is possible to recognize the role that confirmation bias plays in the way we interpret information.

References

• FS Blog. Confirmation Bias And the Power of Disconfirming Evidence.
• Kendra Cherry (Oct, 2022). What Is the Confirmation Bias?
• Statista (Jun, 2022). To what extent do you believe in the conspiracy theory that the moon landing was faked?

Author

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This article is written by Alex Chong Wei Kang, Research Analyst Intern

Alex Chong Wei Kang is a fresh graduate majoring in International Business at University Malaysia Sabah (UMS). Alex onboarded TED Optimus Sdn. Bhd. for 3 months and responsible to research Malaysian listed companies and article writing. He is also a junior research executive in Financial Literacy for Youths: Malaysia, a student-run organization aimed to improve financial literacy amongst youths in Malaysia. He was an in-house author of TED Optimus.