Cognitive Bias Definition
Cognitive bias usually involves making decisions based on established ideas that may or may not be correct. Think of any cognitive bias as a rule of thumb that may or may not be true.
Types of Cognitive Bias
There are ten types of cognitive bias that is part of the behavioral finance.
(i)Familiarity Bias:
Familiarity biases are indeed the most common biases that are seen in everyday life.
Common Occurrence:
This bias is commonly seen in individuals who love to live within their comfort zones. Such individuals fear to travel the unthreaded path as unfamiliarity makes them uneasy.
(ii)Representativeness:
Representativeness is a widespread bias that is governed by the image, representation or past performance of a company.
Common Occurrence:
When the availability of specific information like extended news coverage of a highly performing stock spreads like a fire, it grabs the attention of potential investors immediately.
(iii)Anchoring Bias:
Anchoring refers to using irrelevant information as a base to make financial investments.
Suppose you see a house that cost of Rs 70,000 and then another house that cost of Rs 30,000, you could be influenced to think the second house is very cheap. Now, you saw a Rs 7,000 House first and the Rs 30,000 one second, you might think it’s very costly.
Common Occurrence:
Anchoring bias is commonly seen in both naive as well as professional investors. However, professional investors have more access and exposure in investments to gauge themselves if they are letting these biases influence them.
(iv)Overconfidence Bias:
Overconfidence refers to an investor having a bias towards his prediction skills, his judgments about the market behavior and his cognitive abilities.
Common Occurrence:
Investors convince themselves that they are better than others and start to ignore earlier signs of potential damage.
(v)Herd Mentality Bias:
Man is a social being. He does not like to cut out from a trend or to option out from a movement. And marketers know this very well.
They try to position a product to create a brand such that people start relating to it and some people keep joining it. So, this becomes a trend and others blindly follow it to be a part of a social norm.
Common Occurrence:
One reason for herd mentality bias is the human tendency to adhere to social pressure and customs.
(vi)Commitment Bias:
The biasness refers to the tendency of investors of being stuck to their original beliefs regardless of the dynamic market conditions.
Common Occurrences:
Committment bias is usually seen in our day to day lives when we do things or take decisions only to approve or justify our past actions.
(vii)Do Something Bias:
It is a tendency of investors to act. It can also be said to be the lack of ability of investors to sit ideal. It can also be said to be tendency to act on every happening rather than sitting back and waiting for the right time to act.
Common Occurrence:
It is also commonly seen when investors portfolio is not performing well, so it gets very difficult for him to sit ideal and wait for the market to recover.
(viii)Status Quo Bias:
It refers where people don't do anything and continue to maintain their current status. It is like living your life in an 'autopilot' mode.
Common Occurrence:
One of the reason for this kind of bias is human tendency to procrastinate.
(ix)Conformation Bias:
Conformation bias indicates the tendency to use or interpret a piece of information to support your perceived notions and ignore the ones that are contrary to your beliefs.
(x)Hindsight Bias:
It is biased in which a person believes that the previous events were predictable and obvious. Such biases happen now and then in our daily lives.
Common Occurrence:
Hindsight biases occur due to this innate desire to bring order to lives. People tend to look for simpler solutions to all complicated problems and thus tend to overthink and develop such biases.
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