Biases Impacting Equity Investors

Biases Impacting Equity Investors

Introduction :

Fundamental analysis and technical analysis are initial and important aspects of investing in shares. However, they are not the only driving factors. Psychology of individual investor is also equally important in undertaking investment decisions. In fact overall Success or failure of an investor will have a major component of perception and psychology with which he/she approaches the markets involved. A bias is a faulty way of thinking that we have grown accustomed to. Bias is a disproportionate weight in favor of or against an idea or a thing, usually in a way that is closed-minded and normally leads to loss in investing environment. We will share with you a few biases which investors suffer from and have adverse impact on their overall investing performance :

(We have to view all the information just the way it is (without any form of distortion). In this image number appears 6 from one angle and 9 from another angle.However, the context in which the number has been written is very important to understand before deciding whether it is 6 or 9)

• Confirmation Bias : Confirmation bias is the tendency of people to pay close attention to information that confirms their beliefs and ignore information that contradicts it. Confirmation Bias tends to limit our ability to make rational investment decisions. Have you noticed that you put more weight into the opinion of those who agree with you ? Investors do this too. How often have you analyzed a stock and later looked for research reports supporting your thesis ? We all have done this. Solution from this type of bias is that if we come across contradicting information which does not support our investment thesis then instead of directly rejecting it, we can look at facts/information on the basis of which such opinion is generated. If the contradicting information makes sense then it is possible to get out of a bad investment at a small loss or avoid it altogether

• Recency Bias : Recency bias is tendency to overvalue the most recent information available to us, because that information is fresh in our minds. If we recently heard about a company doing really well or having trouble, we may over rate that information and ignore everything that happened before. Solution from  this type of bias is to not ignore the past information and assign equal weight to both old and new information for decision-making in investing

• Loss Aversion Bias : Loss aversion is a tendency where investors are so fearful of losses that they focus on trying to avoid loss than on making gains.Research on loss aversion shows that investors feel the pain of a loss more than twice as strongly as they feel the pleasure of making a profit. Many investors don't acknowledge a loss as being such until it is "realized". Therefore, to avoid experiencing the pain of a real loss , they will continue to hold onto a investment even as their losses from it increase. Negative effect of this is that investors often continue to hold onto investments much longer than they should and end up suffering much bigger losses than necessary. Solution from this type of bias is to have a stop-loss in place for investments are well as for trading

• Availability Bias : While researching a company, investors tend to focus on data and information which is easily available to them. This is called Availability Bias. Instead of looking for important piece of information which may not be easily available, investors having this type of bias formulate their investment thesis on the basis of information which is easily available but may not be actually relevant from decision-making standpoint. Solution from this type of bias is to identify list of important information at the beginning of research and then start looking for the same