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Always mind the confirmation bias!

16 Jan 2018,

Do you know what is the confirmation bias? Each of us has witnessed it at least several time during our lives.

 

 

What is the information bias?

It simply means that we tend to prefer information that confirms our own opinion. Typically, it is happening during the elections. For example, there were many people who didn´t know a single person who would have voted for Donald Trump. People who are ignoring this concept are then rather convinced that the votes are manipulated. But they are not. It is related to the fact that everyone has a social group around themselves and in this case, this group was simply not attracted by Donald Trump, so they didn´t vote for him (we should not offend those who were voting for him).

How does the confirmation bias work in trading?

When trading on the stock market, we have some opinion at the beginning. A typical example can be the current situation on EURUSD. At first glance, we can see a nice signal for buying at D1 (head-shoulder formation) but we get also the warning signals – COT, seasonality … We tend to look for reasons why COT does not work and why other signals confirm going long. There is a little bit (a lot) of ego behind this when we do not want to give up our first analysis and we just want to be right.

Note: Currently, EURUSD is rising, so it’s possible that for some of you this will be the evidence that COT does not work. But think of confirmation bias, there is nothing that works for 100%, even head-shoulders formation.

More often, the confirmation bias appears in the stock analysis. Why? It’s very easy – the amount of information. When analyzing EURUSD, 99% of traders are only interested in one point of view – technical analysis. If we analyze stocks, there are many factors in the game – accounting, the entire sector, management reports … We often have dozens of resources to analyze the action. And it’s hard to accept that, for example, STON, our favorite cemetery operator who has paid us a 10% dividend for years, is economically doing badly and has been on the edge of bankruptcy for several years. Then we only accept the information that confirms our idea to speculate on a long-term growth. Although we have got 80% negative and 20% positive news, our brain gives to the negative so little attention that the positive ones will eventually win. This is a typical demonstration of confirmation bias in practice – we want to grow, we ignore negative information, or we give it very little importance.

How to beat the confirmation bias?

I would lie to say that I am not concerned. Fortunately, I know how to fight with it. And I’ll tell you how I do it.

Keep in mind the confirmation bias and its negative impact on your mind and remember that you need to have an unbiased look. Whenever you analyze the market, read information about the analyzed action, etc., remember the confirmation bias. Always, with every message, every article, at any time. With time, you will get into the head and it will be automatically there. E.g. When I analyze a market, the red sign “confirmation bias” automatically blinks in my mind. It tells me not to forget the unbiased point of view. As a tool, you can print (or write) “confirmation bias” with red color and stick it on the monitor.

You can train this by yourself, and it is absolutely crucial for the successful trader’s career!

 

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