3 behavioral biases you’re struggling with right now | a cautious investor

I’ve spent most of my career helping investors become like pilots. Why is this an important mindset to adopt? Well, pilots must maintain good situational awareness and understand what is happening around them. They must make difficult decisions and recognize when circumstances change. And perhaps most importantly, they must fight and be guided by their emotions. Otherwise, you could get into serious trouble.

First solo flight, Norwood Airport (KOWD), July 7, 2012.

Author’s Note: Fun fact… I Video celebrating my first solo flightAnd I think that was the first video I ever uploaded to YouTube!

The emergence of behavioral finance as a legitimate field of study has helped investors identify and categorize a series of cognitive and emotional biases. Today, I’ll share the three most common indications by investors, from seasoned market experts to novice traders. I’ll also share some technical analysis tools that can help you minimize any potential negative impact on your portfolio!

Think about where these biases come from in your process, and hopefully you can identify some tools in StockCharts that can help you minimize their disastrous impact on your bottom line.

confirmation bias

The most common bias in my experience is confirmation bias. Basically, it’s about gathering evidence to confirm a decision you’ve already made. Now what actually happens is that you are often presented with a lot of evidence that can either support or undermine your investment thesis. Your brain places greater value on evidence that supports your thesis, and mentally pushes away evidence that would contradict your opinion.

Social media tends to exaggerate the effects of confirmation bias. Because every time you “like” or “follow” a specific account with a particular approach or perspective, you are teaching the algorithm to provide you with more content with a similar voice and perspective. . So basically you are teaching social media platforms to continue to offer more of the same.

The right way to develop an investment thesis is to gather evidence, consider the weight of the evidence, and then make a decision. I call this my “evidence-based process,” and it is at the core of how I use charts in my daily and weekly routine. Actually, my morning coffee routine is It uses broad market averages, breadth and sentiment indicators, cross-market analysis, sector and thematic plays, and a series of charts to help you examine conditions for individual stocks.

The best way to combat confirmation bias is to have a solid chart review process in place and then consistently and religiously seek out alternative hypotheses and opposing viewpoints. Social media platforms don’t make the process particularly easy, but your portfolio will thank you for your effort to consider diverse perspectives!

descriptive bias

“The S&P 500 will rise further as the Federal Reserve lowers interest rates and semiconductor stocks will rise further due to the AI ​​craze.” If you’ve ever said a sentence like that, you’ve likely set yourself up for something called narrative bias.

We love stories. This is especially true when we are the main characters. That’s why when you go to buy a car, the salesperson will let you sit in the driver’s seat and take it for a test drive. Because at that point, you’re no longer thinking about the price tag and just enjoying your story as a new car owner.

Narratives come from an honest place because they are how we as humans make sense of the world around us. Being human is about telling stories, connecting with others, and gaining a better understanding of the human condition. But getting too caught up in a market narrative that ignores changing evidence can be a costly mistake.

The S&P 500 hit a record high this week, amid low interest rates, a more dovish Federal Reserve, limited fallout from the Middle East conflict, the dominance of mega-cap growth stocks and a low volatility environment. This could be the current state of the market in mid-January 2024. But things can and most certainly will change.

One of the biggest benefits of technical analysis is that it can provide clear levels and signals that help define when a trend change has occurred. In my view, the S&P 500 chart is strong as long as it stays at 4700. A break below 4700 would open the door to a more long-term support level in the price gap around 4550. As long as it stays above 4550 I would say this market is in a clear upward trend.

Now comes the most important part. I set up price alerts in StockCharts This is in case the S&P 500 index reaches its downside limit. And the platform will email me, text me, and pop up a banner on my website when it reaches that level. Want to minimize descriptive bias? StockCharts will tell you when your narrative is no longer working!

overconfidence

Social media (and the markets in general!) is full of overconfident traders and investors. It’s not hard to find examples of people doing virtual victory laps for amazing performance or market valuations.

I have yet to meet a successful investor who hasn’t made some big mistakes in their career. I have heard that these early failures are “tuition paid to the market” as a down payment on future success.

Technical analysis tools can really help increase your confidence in your ability to pick stocks and ETFs, and that’s a very good thing. However, if you have a series of particularly good trades, it can be very easy to think that nothing will go wrong with your portfolio. As many successful traders will tell you, this is usually the time to pull the rug out from under your feet!

Investing is a very humble way to spend your time. I’ve been right more times than I can count, and I’ve been wrong more times than I can count. This is why my trading journal has three lines for every trade.

1. What position am I taking?
2. Why am I taking that stance?
3. How do I know I’m wrong?

But the third line is how I try to avoid overconfidence. Whenever I take a position, I acknowledge that there is a very high chance that I will be wrong. The most important thing is that it explains exactly what you need to check to find out just that.

These are just three of literally hundreds of behavioral biases I have observed over the course of my career. You may find one or two of what I’ve described today resonate with you, and you’ve probably experienced them all. The good news is that a consistent process using charts and technical analysis tools can give you a more objective view of the weight of the evidence and help you make better (and more prudent!) investment decisions.

By the way, I’m very happy to see the S&P 500 hit a new all-time high, but after examining five market breadth indicators, I’m also skeptical about further upside. For more information on the difference between price and breadth in the S&P 500, check out our latest YouTube video!

RR#6,

dave

P.s Are you ready to upgrade your investment process? Check out our free behavioral investing course!

David Keller, CMT

Chief Market Strategist

StockCharts.com

disclaimer: This blog is for educational purposes only and should not be construed as financial advice. You should not use any of our ideas and strategies without first evaluating your personal and financial situation or consulting a financial professional.

The author had no positions in any securities mentioned at the time of publication. All opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.