Have oil prices stabilized? What’s the impact of the Federal Reserve’s decision on interest rates going to have on stock prices? Will a slump in housing sales lead to a severe economic slowdown? These questions reflect important concerns of the day. The media spends countless hours covering them. Media reports impact stock prices. Indeed, market observer David Dreman notes that a large part of the market action is dictated by the opinion of the masses. And who is a major influence on mass opinion? The media is one of them, and it’s wise to keep abreast of the latest developments. The coverage by the media can’t be underestimated, but the astute trader knows how to quickly sift through the barrage of information and how to use this information to trade decisively.
It’s hard to study, evaluate and synthesize a complex flow of information. The capacity of the mind is limited, and when you attempt to understand and digest a wealth of information while dealing with the uncertainty of the markets, it’s easy to give into judgment biases. It’s essential to eliminate these biases in order to make logical, prudent decisions. For example, Dr Donald MacGregor and colleagues at Decision Research showed that preconceptions tend to bias forecasts of stock performance. For example, if you think industry or sector is “hot,” you’ll tend to believe that all stocks in the industry group will go up.
They may go up, but not all stocks in the industry or sector will go up, or if they do, they may not increase at the same rate. It’s important to be aware of the powerful effect media images and memory biases may have on your forecasts. These days, media reports of oil prices and interest rates may stick in our mind and unconsciously impact our investment decisions. You cannot help but think that higher oil prices and steadily rising interest rates will make you believe that stock prices will decline. But the impact may not be as strong as you think, or it may not impact all stocks within a sector or an industry group in the same way.
In addition to memory biases, people also have a strong bias to believe that when they do make a decision, others would make a similar decision to theirs. They believe in a false consensus in that they think, “Upon sifting through the available information, anyone would draw the same conclusions I did.” But other people may not agree with you. You may be wrong. Your decision may have been biased, and if you assume that the masses would behave as you did, you may suffer the consequences of a poorly thought out decision.
When sifting through the barrage of information from the media and other sources, there is a strong urge to reduce the tension of uncertainty by following inaccurate judgment biases. Many times our hunches are accurate, but other times, they are the result of unconscious processes to alleviate anxiety. It’s essential to conquer these biases. The more you can perceive the markets accurately, the more you can trade them profitably.