According to Science Daily, confirmation bias is "a tendency to search for or interpret information in a way that confirms one's preconceptions." This is a dangerous trap to fall into while trading or investing.
When considering an investment or even trying to justify an already-made investment, people often try to seek the opinions and data that confirm their investment thesis. For instance, if one makes an investment in a Chinese Solar company, they may only seek data that confirms how China is growing rapidly, energy prices are rising, and the Chinese government is subsidizing the development of solar farms throughout the country. By focusing only on the positives, they may ignore looming negatives that could change their thesis or give them reason to sell. For instance, the valuations on the company may be exorbitantly high or management may not be acting in the best interest of their shareholders - thus, this may be reason to sell, but the investor has missed it or decided to ignore it completely.
When considering an investment or even trying to justify an already-made investment, people often try to seek the opinions and data that confirm their investment thesis. For instance, if one makes an investment in a Chinese Solar company, they may only seek data that confirms how China is growing rapidly, energy prices are rising, and the Chinese government is subsidizing the development of solar farms throughout the country. By focusing only on the positives, they may ignore looming negatives that could change their thesis or give them reason to sell. For instance, the valuations on the company may be exorbitantly high or management may not be acting in the best interest of their shareholders - thus, this may be reason to sell, but the investor has missed it or decided to ignore it completely.
To weigh the accuracy and strength of one's investment, it's imperative for one to seek both the positives and negatives. By focusing on the negatives, an investor avoids the confirmation bias and can develop into a more independent, confident, and analytical investor. Further, a focus on the negatives can help you zone in on what the company needs to improve upon in the future.
Before implementing his multi-billion dollar trades in the subprime market, John Paulson sought out opinions on WHY his investment thesis would not pan out. He asked analysts all across the country, why will buying insurance on CDS's fail? Why will the housing market bubble not burst? After hearing the opinions of those on the opposite side of his trade, Paulson's original investment thesis was strengthened, he knew what to look for, and he became ever more confident in his wildly successful trade.
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