Monday, June 12, 2006

>15 common biases that can lead to bad decisions

Decision-Making Biases

1) Availability: Drawing conclusions based only on vivid and recent information.

2) Irretrievability: Failing to think beyond a preconceived notion.

3) Presuming associations: Assuming certain associations exist with no real evidence.

4) Confirmation trap: An unconscious search for supporting evidence that the right decision has been made, while ignoring evidence that a bad decision was made.

Measurement Biases

5) Sample size insensitivity: Reaching a conclusion based on a small sampling of information that does not truly represent the complete situation.

6) Ignoring regression to the mean: Not recognizing that above-or below-average results won't necessarily continue forever.

7) Conjunctive and disjunctive events bias: Mis-estimating the likelihood that certain events will occur when those events must take place for a particular outcome to occur.


8) Insufficient anchor adjustment: Assuming an outcome of an event will be exactly the same as the outcome of a similar prior event without examining differences.

9) Hindsight: Evaluating a judgment after an event has played out and with perfect knowledge of the outcome.

10) Positive illusions: A tendency toward overly optimistic views of things rather than a realistic assessment.

Taking Biases

11) Avoiding uncertainty:
A preference for stability rather than uncertainty.

12) Asymmetry of risk tolerance: Investors are risk-averse with regard to gains (preferring to sell "winners" and ensure the gain) but risk-takers when it comes to losses (preferring to hang on to "losers").

13) Regret avoidance: Investors tend to feel more regret toward committed actions that have turned out badly rather than omissions that could have turned out favorably.

14) Internal escalation of commitment: The tendency of an investor to increase the support of their initial decision over time.

15) Competitive escalation: The tendency of some investors to view competitors' actions or other investors' collective actions as validating an investment idea.

Recognizing these biases is important. I'm sure if you think about some of the bad trades and investments you've made in the past year, you're likely to discover one of the biases affected your judgment. At least I know I can.

Bottom line - by understanding that these biases exist in your own decision making process will ultimately help you control and overcome them. Print out this list and keep it somewhere so when you take time to analyze your past trades you'll know what to look for.

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