How to overcome our biases while selecting stocks
Great investors are great thinkers. They allocate most of their time in thinking about businesses they have bought or companies they are going to buy. The clarity in our thinking is one of the key traits of successful investing. But most people calculate too much and think too little. Investors have to make thinking about their habits. There is no single investor who has a hit rate of 100%. The greatest legends in investing also go wrong in their investment decisions. It has to be clearly understood that, while investing we should not aim to get all our calls right. Some calls may go terribly wrong, some may do average and some might blossom beautifully in the long run. Investment mistakes in our financial journey are inevitable. Once we realize that, we cannot get all our calls right then we become more risk-averse. It has been noted that the large part of our investment mistakes is due to our overconfidence in our decision making capability, most commonly known has overconfidence bias.
Investors generally overestimate their ability to predict the future of the company that they are going to invest. Overconfidence may lead to disastrous financial result because our overconfidence may blind us from risks which we might not have thought off. It is extremely important to not be overconfidence and have little skeptical about the investments we are making. Skepticism helps in having room for error in our decisions. Overconfidence makes us feel comfortable in our investments but this false sense of comfort may be dangerous.
How to reduce overconfidence bias
Stocks in which we have high overconfidence we might have a high emotional attachment. Once we have a high emotional attachment towards any stocks it is extremely difficult to bring back to a normal state. It is necessary to not have any kind of emotional attachment to any stock in our portfolio. One of the ways to not have attachment is not being overconfidence about the investment decisions that we make. Being completely attached to any of our investments leads to ignoring all the negative things and risks associated with those investments and we only want to hear good news which would be supporting our investment decisions. This bias is known as confirmation bias.
After we make certain investments and get too much emotionally and psychologically attached to certain stocks then, if in case any negative news or events happen to the company we bought, then we would just ignore that negative events and instead search for news which support our beliefs that the company is good about the investments because we are emotionally attached.
Confirmation bias binds not only our eyes but also our mind in taking good decisions. The researcher has found that it is nearly impossible to completely eliminate confirmation bias but it can be reduced.
How to reduce our confirmation bias
If we strongly believe that certain company, for example, ABC Ltd that we have bought is going to do well over a period of time, then we should find the facts and data with proper reasoning which says that ABC Ltd is not going to do well in long run. By doing this we are disconfirming our own thinking and this leads to reducing in having confirmation bias which leads to taking proper decisions. This idea is simple but powerful.
It is very much necessary to key our emotion in check when we make any decisions. Since humans are an emotional creature and most of the time we are always in a certain state of emotion. So, will taking decisions we must check that we are not in an emotionally excited or emotionally depressed state.
Emotions are the enemy of the rational decision maker. We humans cannot completely take rational decisions all the time but we should avoid making any irrational decisions. Making no irrational decision itself is a huge advantage for investors. As Charlie Munger says that “to make money in investing, we should not make stupid things”. Investors do make mistakes along with their career but as long as we don’t make stupid things, we are way ahead of many of the market participant.
Investors have to get emotionally equipped to ride the market. It becomes tough for an investor who is emotionally weak to see his portfolio companies turning red. Investors having emotional stability with reasonable knowledge about business are destined to do well in markets.