Greed + Confirmation Bias = Disaster

If I could force-feed my readers a single concept to consider every day in their investing and trading endeavors, it would be to be cognizant of the perils of confirmation bias, and to do their best to avoid falling into the confirmation bias mindset.    I’ve written about confirmation bias previously, on more than one occasion, but the topic is essential so I’ll write about it again.

My summary of my thoughts on avoiding confirmation bias are simple:

When you’re in a trade or an investment, you should be more eager to hear from the people who disagree with your thesis than from the people who agree with your thesis.

Notice, however, what most people naturally do:  we surround ourselves with message boards, commenters, online communities, gurus, etc who *agree* with what we already believe and reinforce or comfort our views.  That’s “confirmation bias.”   There’s nothing especially disturbing or unusual about this natural trend: that we enjoy being told that we are correct, and surrounding ourselves with people who agree with us – but it doesn’t help enhance your development of an investing thesis.   Being told you’re wrong, however, well, let me go to the trade-marked Self-Quote technique:

“It’s a natural human tendency to seek out conforming opinions – people who agree with us.  It makes us feel “right” and good about our decisions.  In the investing world, however, this is dangerous.  When I form an investment thesis, I’m always trying to figure out why it’s WRONG, not why it’s RIGHT.    I want to know the thesis of the guy on the other side of the trade as me – and then I can evaluate whose thesis is stronger.  Ideally, I get comfortable with the thought process of the other side of the trade, can confidently debunk it, and gain confidence in my position.   More likely, I realize what I may have been missing, or understand how the data can be interpreted differently,  and learn what I need to keep an eye on while carrying out the trade.”

So think about the kind of discussions you participate in about investments when you’re online (or anywhere, for that matter).   The next time you want to attack the guy who doesn’t like your long idea as a “paid shill” or a “desperate short,” perhaps instead you should think about WHY he has the view he has – WHAT he is saying.   Perhaps you’ll conclude that he’s an idiot, and that your thesis is stronger for having considered weaknesses in the opposing thesis.  Perhaps you’ll realize something you were missing and keep a closer watch on developments in your own thesis.  Perhaps you’ll realize that your thesis was the one that was lacking and reverse your view entirely.

I wrote this post today because I read Josh Brown’s recent post which cited Fortune’s chronicles of $AAPL (no positions) “guru” Andy Zaky.  Take a bunch of investors who were long AAPL, add in a “guru” who told them that the stock would keep going higher (which, of course, was what they wanted to hear anyway!), throw in a dash of suspect advice like swapping stock for call spreads (increasing leverage and adding time constraints), pile on a heaping dose of GREED, and you get, well disaster.    And then you get more disaster.    Zaky’s last “buy” call on AAPL  – with the prediction that the stock would reach $1000 with in 15 months –  was chronicled in Fortune on September 18th, 2012, with the “endorsement” by the author of:

“I mention this because Zaky, a former Fortune contributor who now runs the only Apple hedge fund I know of, has a pretty good track record on these things — like four for four.”

Here is a one year chart of AAPL:

AAPL_1yr

If you want to know where Sept 18th 2012 is on the chart above, just look for the top.

Zaky still has plenty of time left on his “$1000 within 15 months” call, but unfortunately, due to options strategies employed, it seems his investor’s capital has already been permanently impaired.

Let me close this post with a proposition to make a point, because I think that an area of the market where I see constant and relentless confirmation bias is in the precious metals.    If I were to write two posts on gold, which one do you think would get read more by goldbugs?

a)  “Why Gold is Going to $5,000 an ounce soon

or

b) “Why Gold Could Trade Back Down to $1,100 an ounce

I’ll leave it to Daniel Kahneman to actually do this experiment, but I’d bet my left nut that the answer is “a.”   This confirmation bias phenomenon isn’t unique to goldbugs of course – that was the entire point of the first 3/4 of this post! – but along with Apple Fanboys, I have found the precious metals devotees to demonstrate some of the most strident confirmation bias anywhere.   Does anyone seriously want to argue with my claim that members of the “Buy Silver, Crash JP Morgan” movement would rather read the hypothetical post:

a) “MASSIVE SILVER SHORTAGE – THE MORGUE WILL BE DEFEATED SHORTLY”

than

b) “Data Shows No Shortage of Silver”

??

Please, dear readers, remember that being told what you want to hear doesn’t make it any more likely to become reality.

Avoid confirmation bias at all costs.

What American Idol Taught Me About Confirmation Bias

Confirmation Bias Is A Portfolio Killer

Fortune: The Rise and Fall of Andy Zaky

Fortune: Losses of Apple Guru’s Clients Could Reach Into the Billions

Fortune: Andy Zaky:Apple Will Cross $1000 Within 15 months

So You Still Think JP Morgan Is Short Billions of Ounces of Silver?

-KD

disclosure: no positions in gold or $AAPL

 

 

 

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