S2.E5: Behavioral Insights into Investing - Confirmation Bias

Why do investors keep finding evidence that supports a stock they already believe in?

This episode of My Two Cents: Behavioral Insights into Investing explores confirmation bias through the dot-com bubble and a study of nearly 400,000 StockTwits users. We look at how investors create information echo chambers, interpret good and bad news differently, and allow an investment thesis to survive even when the evidence begins to weaken.

Research featured:

A Mind Is a Terrible Thing to Change: Confirmatory Bias in Financial Markets
https://academic.oup.com/rfs/article/30/6/2066/2740622

Echo Chambers
https://academic.oup.com/rfs/article/36/2/450/6670640

Transcript

Intro - Confirmation Bias

SPEAKER_00 0:14

Hey everyone, welcome to My Two Cents. I'm your host Mahima, and this is Behavioral Insights into Investing, a series about the habits and emotions that can shape what we do with money. Before we begin, this episode is for educational and awareness purposes only. It is not investing advice and it is not telling you what to buy, sell, or trade. Today's bias is confirmation bias, the tendency to pay more attention to information that supports what we already believe and brush aside information that challenges it. Researchers have studied how this affects the way traders search for information and hold on to their personal views. Confirmation

What 400,000 Investors Revealed

SPEAKER_00 1:03

bias can begin before we even decide whether information is convincing or not. It can help shape which information reaches us in the first place. Researchers studied about 400,000 users on StockTwits, a social network where investors discuss individual stocks. They compared users who described themselves as bullish with those who described themselves as bearish. The bullish investors were five times more likely to follow someone who was also bullish about the same stock. Over a period of 50 days, they saw dozens more positive messages and fewer negative ones from bullish investors than bearish ones following the exact same company. Nobody had to deliberately hide the opposing evidence. It's the small choices about whom to follow that gradually created two different versions of the same stock. By the time people formed their own opinion, the information surrounding them was already leaning in one direction.

The Dot-Com Story

SPEAKER_00 2:15

This effect grows stronger when the same optimistic story starts spreading and circulating across the market. A larger version of this played out during the dot-com boom in the late 1990s. The internet was really changing the world. New companies were appearing, investors were excited, and the idea of a new economy felt very convincing. For some investors, that excitement made it easy to overlook basic questions. Did the company have customers? Could it eventually make a profit? Did the share price make sense? As prices rose, the optimism seemed justified. More money flowed into technology stocks, and the excitement kept building. Confirmation bias was only part of the picture. Factors like hurting, overconfidence, speculation, and easy access to capital also played a role. Still, it became easier to focus on good news and find explanations for anything worrying. The Nasdaq composite reached its dot-com era peak in March of 2000. When expectations began to weaken, investors paid more attention to losses and fragile business models that had been visible for quite some time. By October 2002, the index had fallen roughly three quarters from its original peak.

Cognitive Resistance to Beliefs

SPEAKER_00 3:48

Confirmation bias affects more than the information people notice. It can also affect how much weight people give that information. Suppose an investor expects a company to grow quickly. A strong quarter may be treated as proof that the original thesis was correct. A weak quarter may be dismissed as temporary, blamed on the economy, or pushed into the future with the promise that growth will arrive later. Each explanation may sound reasonable on its own. The problem is that positive evidence changes the investor's confidence, while negative evidence just changes the explanation. Over time, the investment thesis can become difficult to disprove. One way to reduce confirmation bias is to make room for a useful question. What outcomes, factors, or events would make this idea wrong? Some investors also keep a simple bull case or a bear case with the strongest points on both sides. Research

Conclusion

SPEAKER_00 4:57

on confirmation bias suggests that the problem begins with both information selection and interpretation. Investors may surround themselves with views that match their own and then examine supporting evidence more generously than evidence that challenges them. The dot-com bubble shows how this can matter beyond a person's portfolio. When investors become attached to the same optimistic explanation, the warning signs may receive less attention. That does not mean every confident investor is biased, or that disagreement automatically makes an idea weak. Research suggests that better decisions begin with a genuine willingness to test the original view. This has been My Two Cents Behavioral Insights into Investing. Thanks for listening.