5 Big Investing Errors and How to Fix Them By KEITH KAPLAN, CEO, TradeSmith Daily As investors, we're often our own worst enemies.
We like to believe that we make rational decisions with our money.
Unfortunately, we often fall victim to subconscious errors in our thinking.
There are endless ways human nature can trick us into making less-than-ideal choices with our money. Some of the most common ones are called "cognitive biases."
So today, I'd like to share five common biases that often lead investors astray and how you can protect yourself from them.
(These ideas assume you're already following good risk management strategies. Click these links to learn about trailing stop losses and proper position sizing.) 1. Confirmation Bias Confirmation bias is when you focus on information that confirms what you already believe... while ignoring anything to the contrary.
Say you're bullish on a stock. You're probably more inclined to notice (and believe) positive news about that stock than negative news.
That's an especially serious risk in the era of social media and "fake news." It's not hard to find data that supports even the riskiest of investment ideas.
Giving in to this bias can lead to a false sense of security and taking more risks than you should.
To protect yourself from confirmation bias: - Try to keep an open mind with new ideas and information – especially those that conflict with what you believe.
- Take the advice of billionaire investor Charlie Munger, who once said, "I never allow myself to have an opinion on anything that I don't know the other side's argument better than they do."
- Share your investment ideas with unbiased friends or colleagues. See if they agree with your thesis.
- Periodically revisit the reasons you've made an investment to confirm they still make sense.
2. Oversimplification Bias This is when you try to break complex ideas into clear, straightforward explanations.
Now, don't get me wrong. This is a useful skill in many areas of life. But there are plenty of investment paths that should be tread carefully because they're inherently complex.
For example, regular TradeSmith readers know I love to trade options. When done correctly, options trading can be incredibly safe and profitable.
But if you don't understand how options work, you can easily blow up your account with them.
To protect yourself from oversimplification bias: - Stay within your "circle of competence." Be honest with yourself about your investment experience and knowledge. If you don't understand a particular investment or strategy, avoid it until you do.
- One great way to do this is to "paper trade" any new strategy with a simulation account. You can find these for free at lots of different brokerages.
3. Overconfidence Bias Overconfidence bias can lead you to make impulsive decisions and take on more risk than you otherwise would.
Most of us are guilty of this in some areas of our lives. But it's common among investors, especially those who experience early success (like I did).
In investing, this bias is especially dangerous if you've been on a hot streak and think you're unstoppable.
To protect yourself from overconfidence bias: - Review your past investment decisions and be objective about how they worked out. Make a point to highlight examples when you got overconfident and then saw poor results.
- Consider performing a "premortem" before you make a new investment. This process is a favorite of Nobel Prize-winning economist and behavioral psychologist Daniel Kahneman.
To do this, first imagine it's sometime in the future — anywhere from a few months to several years — and the investment or strategy you're considering has performed incredibly well. Now, try to brainstorm all the potential reasons it did so well.
Then do it again... only this time imagine the performance is terrible. Try to think of all the potential reasons for that failure.
This process can help you see potential risks (and sometimes benefits) that you may have overlooked due to overconfidence. 4. Information Bias This is when you believe more information will always improve your decision-making.
Again, this is particularly common in investing.
Investors are flooded with financial news and information 24/7. Unfortunately, much of this content is little more than "noise" that doesn't help you make better decisions with your money. Instead, it can lead to "information overload," indecision, and over-trading.
To protect yourself from information bias: - Limit your intake of financial news and media. Reading the newspaper or investment research is fine; mindlessly scrolling through financial news websites or social media can be a problem.
- Have a plan and stick to it. Decide in advance when or why you'll sell any position, be patient, and allow your thesis to play out. As I've said time and again, trailing stop losses do the heavy lifting here.
- Don't track your portfolio more frequently than necessary. Unless you're a short-term trader, you probably don't need to check your portfolio every day or even every week. That is particularly true if you use TradeStops or another system that alerts you to important events.
5. Herd-Mentality Bias Finally, there's herd-mentality (or herd-behavior) bias: our natural tendency to "follow the crowd."
It's not hard to imagine where this came from. Humans have survived for 300,000 years because we're smart, resourceful – and we cooperate. We naturally want to conform to what we see others do.
This instinct to "fit in" is still helpful in many areas of life. And following the herd typically feels safer. But as investors, it can lead us to take excessive risks and make foolish decisions.
Remember the meme stocks, dog-themed cryptos, and digital pictures of apes and rocks that were all the rage in 2021 and 2022... never to be heard from again?
The fortunes lost on these "investments" tell you all you need to know about the consequences of this bias.
To protect yourself from herd-mentality bias: - Make it a point to form your own opinion on any potential investment. You may still ultimately agree with the consensus view, but at least you'll better understand the potential risks if things go wrong.
- Take your time considering a popular investment. Feeling like you need to act quickly is often a red flag that you're being overly influenced by herd mentality.
- Understand that the crowd is often wrong at extremes, but it isn't ALWAYS wrong. Blindly taking the opposite (or "contrarian") stance can be as risky as following the herd into any investment.
The Bottom Line Completely avoiding these hard-wired tendencies is not easy. Even successful professional investors aren't immune.
That's why the ones who turn out to be the most successful are the ones who are disciplined. They develop a fact-based process and stick to it. They manage risk with quantitative systems like TradeStops... and through relentless position sizing. Sure, long years of experience will give you a much more informed opinion than the next guy. But that's ultimately all it is: an opinion. It still has to stand up to the harsh scrutiny of hard data like what you'll find on your TradeSmith Finance dashboard. And simply understanding how these cognitive biases work — and practicing a few simple strategies to protect yourself — can make a huge difference in your long-term success.
Which of these biases have you experienced as an investor? Have you struggled with any others? I'd love to hear from you at feedback@tradesmithdaily.com. While we can't respond to every email, we do read them all, and we'd love to follow up on your emails on this topic in a future TradeSmith Daily.
All the best, 
Keith Kaplan
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