![]() Whereas, if you saw a $5,000 car first and the $30,000 one second, you might think it’s very expensive. If you see a car that costs $85,000 and then another car that costs $30,000, you could be influenced to think the second car is very cheap. #7 Anchoring BiasĪnchoring is the idea that we use pre-existing data as a reference point for all subsequent data, which can skew our decision-making processes. This cognitive bias is similar to the framing bias. It means we can be prone to choose less desirable outcomes due to the fact they have a better story behind them. The narrative fallacy occurs because we naturally like stories and find them easier to make sense of and relate to. Investors may pick investments differently, depending on how the opportunity is presented to them. In other words, if someone sees the same facts presented in a different way, they are likely to come to a different conclusion about the information. #5 Framing Cognitive Biasįraming is when someone makes a decision because of the way information is presented to them, rather than based just on the facts. The more losses one experiences, the more loss averse they likely become. Many investors would rather not lose $2,000 than earn $3,000. Loss aversion is a tendency for investors to fear losses and avoid them more than they focus on trying to make profits. There are four main types: s elf-deception, heuristic simplification, emotion, and social bias. When they do this, they are being influenced by emotion, rather than by independent analysis. Herd mentality is when investors blindly copy and follow what other famous investors are doing. ![]() Many of us can recall times that we’ve done something and decided that if everything is going to plan, it’s due to skill, and if things go the other way, then it’s just bad luck. In other words, we attribute the cause of something to whatever is in our own best interest. ![]() Self-serving cognitive bias is the propensity to attribute positive outcomes to skill and negative outcomes to luck. (The desirability effect is the belief that something will happen because you want it to.) #2 Self Serving Bias The most common manifestations of overconfidence include the illusion of control, timing optimism, and the desirability effect. It can be a dangerous bias and is very prolific in behavioral finance and capital markets. Overconfidence results from someone’s false sense of their skill, talent, or self-belief. This guide will cover the top 10 most important types of biases.īelow is a list of the top 10 types of cognitive bias that exist in behavioral finance. Cognitive errors play a major role in behavioral finance theory and are studied by investors and academics alike. A cognitive bias is an error in cognition that arises in a person’s line of reasoning when making a decision is flawed by personal beliefs.
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