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3 Common Cognitive Biases When Investing

Cognitive biases are tendencies to act or think in a certain way, which is incorrect. There is a whole list of cognitive biases that can cloud our judgments or lead us in making unwise decisions. Here are the three cognitive biases that can sway an investor’s decision.

Hindsight bias

Have you ever regretted buying a stock that appreciated in value? And having seen the share price go up, you beat yourself up saying that you knew all along that the price would increase.

Fret not; you are not alone. Many investors suffer from the exact same perception bias known as hindsight bias. In reality, these scenarios are often unpredictable and just because it happened does not mean we could have foreseen it happening.

By not worrying too much about missed opportunities and focusing on the future we can be better investors who do not rush unnecessarily into a wrong decision.

Trend-chasing bias

Investors often look to the past records of companies and try to extrapolate to predict the future. They frequently buy into companies that have risen substantially in recent times as a bid to ride the trend.

However, in reality, the past may not always mirror the future. By concentrating solely on the past performance or past share price appreciation of a company, investors may make poor investment choices that can affect their overall returns.

Investors should not only take into account the past performance of the business but also keep an eye out for what the future has in store.

Self-attribution bias

The bias is a tendency to attribute successful outcomes to one’s own action while blaming bad outcomes on unforeseen external circumstances. I am no stranger to this bias as I have done this numerous times.

This may be one of the most dangerous biases to have as it can lead to overconfidence and misconceptions about investing that can cause grief to the investor further down the road.

Before attributing any success or failures to our own actions, it is important we know exactly why it happened. My Foolish colleague, Chin Hui Leong, wrote an article about how writing down our thought processes can help us rectify this bias.

The Foolish bottom line

Do not be fooled (with a small “f”) into making common investing mistakes due to these cognitive biases. Being familiar with these, and learning to avoid them can help investors make better investment choices down the road.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.