IRCTC Stock and Share Split
A beginner investor's guide to stock split, the headline-making IRCTC stock split and its dramatic stock price spike and dip.
23 Jan, 2023
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Want to know a secret mistake that all of us make but do not realise? Hindsight bias is a folly that makes people waste their money, time and effort without knowing until the end!
What is hindsight bias
Hindsight Bias occurs when people look at a certain event in the present and come to believe that they had successfully predicted it in the past, even though in reality, they never acted upon any such prediction. It usually arises when there is a change in the way we recall the same event based on a new piece of information that has come our way. The impact of such a notion is that the aforementioned people then presume that their future predictions and actions will also be correct, just because they perceive that they have proven capability in predicting events.
The reason why this happens is that the human mind has the capability to rationalise and familiarise itself with otherwise surprising or unlikely events. As a result, once an outcome is known, the mind back calculates a plausible explanation and becomes convinced of that back calculation’s credibility as a formula to predict future events.
A good example of this phenomenon is the period post-2008, i.e. after the 2007-09 market crash - economists, policy-makers, bankers and all claimed to understand the exact reason why the recession took place. But when the mortgage crisis was actually taking shape, very few people actually noticed it or acted upon it.
Hindsight bias vs confirmation bias
Hindsight bias is the sense that a person has that he/she had correctly predicted the present situation far back in the past already. On the other hand, confirmation bias is when someone can only consider facts that support the person’s pre-existing belief regarding the topic, instead of having an open mind and understanding that reality is not linear or clear cut.
Hindsight bias in the stock market
It is important for every trader or investor to remember this - their decisions must be judged based not on whether their decision actually brought high positive returns or not, but on whether the decision they made was a sound and rational one, based on adequate information and clarity.
This means, when a trader suffers major losses in the stock market, they should not lose hope, but only introspect on whether the decisions they had taken were logical and made with adequate information. Similarly, if they achieve major gains, even then they should make sure to double check if it was their strategy that brought them their gains or pure luck.
How to prevent hindsight bias
The best way to do this is to keep a journal of all the major trading decisions taken by you (including the reasons and circumstances based on which you made each decision) so as to come back to them often to understand the improvements made in your decision making process.
Another great way to protect oneself against one’s own hindsight bias is to follow clear cut methods in making decisions in stock trading. For example, it is important to use a widely accepted method of intrinsic valuation (i.e. assessing a stock based on the intrinsic characteristics of the company, based on which a fair valuation of the stock can be made) instead of unclear hunches that are not data-driven. Quantitative factors, such as financial statement analysis, ratio analysis etc. should be used in such cases in order to keep the evaluation process as unbiased, clear and objective as possible. That being said, intrinsic valuation does take into consideration qualitative factors of the stock as well e.g. management quality, vision, business model etc.
Conclusion
Hindsight bias is a solvable problem if the person has identified its existence to begin with. Of course, we humans are forgetful creatures with selective memory. However, when it comes to a high stakes game like investing, it is good to have complete control and clarity on the information and notions that we have in our brains.
If this blog was helpful for understanding the hindsight bias meaning, kindly check out our other blogs as well. If you do not have a demat account already for trading shares, Open demat account for free with Angel One, India’s trusted stockbroker.
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.
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