Confirmation Bias

Definition of 'Confirmation Bias'


A psychological phenomenon that explains why people tend to seek out information that confirms their existing opinions and overlook or ignore information that refutes their beliefs. Confirmation bias occurs when people filter out potentially useful facts and opinions that don’t coincide with their preconceived notions. It affects perceptions and decision making in all aspects of our lives and can cause us to make less-than-optimal choices. Seeking out people and publications with different opinions than our own can help us overcome confirmation bias and make better-informed decisions.
 

Investopedia explains 'Confirmation Bias'


Confirmation bias can create problems for investors. When researching an investment, someone might inadvertently look for information that supports his or her beliefs about an investment and fail to see information that presents different ideas. The result is a one-sided view of the situation. Confirmation bias can thus cause investors to make poor decisions, whether it’s in their choice of investments or their buy-and-sell timing.
 
For example, suppose an investor hears a rumor that a company is on the verge of declaring bankruptcy. Based on that information, the investor is considering selling the stock. When he goes online to read the latest news about the company, he tends to read only the stories that confirm the likely bankruptcy scenario and he misses a story about the new product the company just launched that is expected to perform extremely well. Instead of holding the stock, he sells it at a substantial loss just before it turns around and climbs to an all-time high.
 
Confirmation bias is a source of investor overconfidence and helps explain why bulls tend to remain bullish and bears tend to remain bearish regardless of what is actually happening in the market. Confirmation bias helps explain why markets do not always behave rationally. However, an investor who is aware of confirmation bias may be able to overcome the tendency to seek out information that supports his existing opinions and intentionally seek out contradictory advice.



Filed Under:

comments powered by Disqus
Hot Definitions
  1. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  2. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  3. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
  4. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
  5. Treasury Inflation Protected Securities - TIPS

    A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed.
  6. Gilt-Edged Switching

    The selling and repurchasing of certain high-grade stocks or bonds to capture profits. Gilt-edged switching involves gilt-edged security, which can be high-grade stock or bond issued by a financially stable company such as the Blue Chip companies or by certain governments.
Trading Center