Awareness Does Not Equal Immunity

I've often spoken about behavioral biases and how to minimize their impact on investment decisions.  Being so familiar with all of these biases, then I must be able to completely avoid them in my own investing, right?  A recent interview with Professor Patricia Devine from the University of Wisconsin-Madison shows why the answer is a big "no."

Prof. Devine shared the story of a female student who learned a real-life lesson on the power of behavioral biases.

A former student of mine was responding to an accident on campus, she went to render assistance to a student who was hit by a car. And simultaneously, another woman came to render assistance. This woman was barking commands, she was saying, 'Don't move the head, call 911,' and my student, who's very committed to addressing issues of sexism, looked up at her and earnestly said, 'Are you a nurse?' You can imagine, the woman's not a nurse, she was a doctor.

This was a student who was an advocate for women's rights, and here she was assuming that a woman sharing medical advice was obviously a nurse, not a doctor.  Even though she was sensitive to gender bias, in the midst of a stressful situation she subconsciously fell back to a classic gender stereotype.

Panic is a sudden desertion of us, and a going over to the enemy of our imagination.
— Christian Nestell Bovee

I am very familiar with confirmation bias, and have lectured on the topic to students and professionals for years.  Just because I'm aware of the effect of this bias doesn't mean I'm immune from its effects, especially in a stressful situation.  And the financial markets provide plenty of opportunities to elevate your stress level!

Stress tends to induce what's called the "fight-or-flight response" where our body prepares us to either confront a stimulus or run away from it.  A sudden downturn in a key portfolio holding can initialize this response, causing you to completely ignore your well-thought-out-and-rigorously-designed investment process and instead hit the panic button.

The use of checklists can help you stay centered on your process especially when things get heated.  When I teach technical analysis, I have students answer a series of questions before they can make a recommendation.  

What is the overall trend in the stock?  How has it performed relative to its peers for the last six months?  What are the key support and resistance levels?  And so on.

Don't panic.  Consult the checklist.

Don't panic.  Consult the checklist.

By laying out all of those answers, you're able to draw a conclusion based on the weight of the evidence instead of an emotional response.

Humans are hard-wired to have biases.  The fight-or-flight mechanism is what allowed our ancestors to not get eaten by predators.  But that does not mean it has to negatively impact your investment decisions.


Disclaimer: This blog is for educational purposes only, and should not be construed as financial advice.  Please see the Disclaimer page for full details.