Cognitive Biases in Finance

What it is:

The tendency to search for, interpret, and remember information that confirms your pre-existing beliefs, while ignoring contradictory evidence.

How it hurts you:

You buy a stock and then only read positive news articles about it, ignoring warning signs and red flags that could signal a poor investment.

How to fight it:

Actively seek out the opposite viewpoint. For any investment you make, find the smartest person who holds the opposite view and try to understand their reasoning. Create a "bear case" for your own ideas.

What it is:

The pain of losing is psychologically about twice as powerful as the pleasure of gaining. This makes you overly cautious and prone to bad decisions to avoid any loss.

How it hurts you:

Holding onto a losing stock for far too long, hoping it will "come back to even," instead of selling and redeploying the capital into a better opportunity. You refuse to accept the loss.

How to fight it:

Frame the decision differently. Ask yourself: "If I had the cash value of this investment today, would I buy this same stock with it?" If the answer is no, sell. Use stop-loss orders to automate selling decisions.

What it is:

Overestimating your own knowledge, ability, and the accuracy of your information. Believing you are smarter than the market.

How it hurts you:

Taking on too much risk, concentrating your portfolio in only one or two stocks, and ignoring the proven benefits of diversification because you think you can pick winners.

How to fight it:

Keep a decision journal. Write down why you made an investment and what you expect to happen. Reviewing your past decisions (both good and bad) provides humbling and accurate feedback on your actual skill level.

What it is:

Relying too heavily on the first piece of information you receive (the "anchor") when making decisions. All subsequent information is interpreted in relation to the anchor.

How it hurts you:

Refusing to buy a stock because it's trading at $300 when you remember it was $150 a year ago, even if its fundamentals have improved dramatically. Or, conversely, thinking a stock is "cheap" just because it has fallen from a much higher price.

How to fight it:

Always base your valuation on the company's fundamentals (earnings, growth, etc.), not its past price. When you evaluate an investment, deliberately start with a different anchor or consider a wide range of possibilities.

What it is:

The tendency to follow and copy the actions of a large group of other people, assuming they know something you don't. It's driven by a fear of missing out (FOMO).

How it hurts you:

Piling into a "meme stock" or cryptocurrency at the peak of its hype, right before it crashes. You buy high because everyone else is, and then sell low when the herd panics.

How to fight it:

Develop a strong investment thesis and principles *before* you invest. Have a checklist that an investment must pass before you buy it. This forces you to rely on your own research, not the crowd's emotion.