In this article we cover:

• Anchoring Bias

• Confirmation Bias

• Loss Aversion

• Hot Hand Fallacy

• Why Managing Biases Is Important

For as long as conflicting opinions have dominated the stock market behavioural finance and investor psychology have been underlying principles. This involves trying to understand and rationalise the investment decisions we make.However cognitive biases can interfere with our investment decisions ultimately hindering rational decision-making and potentially leading to crucial mistakes. It is one thing to be confident in your thought process however taking shortcuts or exhibiting overconfidence can be a significant disadvantage.Because long-term share investing is as much a test of one psychological mettle it is important that you understand how to manage cognitive biases as an investor. This may help you improve the sustainability of your returns by reducing your risk exposure.Let discuss some of the most common cognitive biases associated with shares.

Anchoring bias

Have you ever heard of the expression that past financial performance is no guarantee of future performance? This relates to anchoring bias which is the tendency to anchor' your expectations to historical reference points when making an investment decision.An example of this would be where you invest in a stock because it is well below a historical trading range or the price at which you previously bought shares. You might be using the company historical share price to guide your expectations as to its future price. Many traders rely on technical analysis to guide price expectations however this differs because it is based on evolving trends that revise expectations.On the other hand if you are a long-term investor it is dangerous to assume a stock may return to a historical price just because it once traded at that price. Instead you should take into consideration the broader context behind the deviation in the share price to understand what has changed. There may be fundamental reasons that make historical trading prices redundant'. Alternatively you may even choose to ignore historical prices and focus on intrinsic stock valuation.

Confirmation bias

Confirmation bias is where we seek out information that supports or confirms our existing views on a stock and disregards contrarian views. Without realising you might be collecting data that reinforces your investment thesis but does not include all the information that is publicly available. In fact this may tie-in with another bias groupthink which could lead to a false sense of confidence a lack of independent analysis and poor judgement.While no one likes to be told that they are wrong it pays to consider every share investment with an open mind rather than being emotionally attached. To overcome confirmation bias you should actively and regularly seek out contrary information that challenges your investment thesis and offers a complete picture thus increasing the likelihood you make an appropriate investment decision.

Loss aversion

Shareholders often have a hard time parting ways with a stock that is currently trading at a paper loss'. Many hope to claw back their capital. Loss aversion explains this tendency suggesting that we sometimes prefer to avoid losses than realise gains. A similar bias called the endowment effect involves holding onto a stock due to increasing bullishness as the price rises. You can mitigate this if you stick to the objectives of your trading plan.Behaviour associated with loss aversion goes against the fundamental principle of opportunity cost which is the lost' gain when you invest in one opportunity instead of another. While you might be inclined to hold onto shares that are currently trading below your purchase price you should ask yourself whether your capital is best allocated to those stocks. Could you achieve higher returns if you invested in other shares?Continually assess your trading account to gauge whether alternative shares represent better value. Losses often magnify. Try place yourself in the shoes of someone else to frame your judgement as to which shares will maximise your portfolio. Furthermore view your past decisions as a sunk cost that has no bearing on the current decision in front of you.

Hot-hand fallacy

Have you ever found yourself in the middle of a good streak where you thought that you were on a roll? We often tend to convince ourselves that this success is likely to continue even though each successive event is mutually exclusive.In the stock market traders regularly exhibit this tendency otherwise known as hot-hand fallacy. It may be because you are overconfident in your strategy however it can often lead investors to start taking shortcuts and relying on instinct. This is why it is important that you do your research on every opportunity before you decide to invest.Sometimes this fallacy extends to hot' trends in the stock market where investors assume they will continue. Momentum investing can work but nothing is a given especially when the trend reverses. Just ask shareholders of cannabis stocks how this strategy has fared for them over the last 18 months.

Why managing bias is important

Over the long haul the stock market can be a true test of attrition. To position yourself to achieve sustainable returns it is beneficial to understand your behavioural mindset when investing in shares.It is only normal that we exhibit cognitive biases in our investment decisions however overcoming these biases is a key differentiator that can help you make rational judgments and avoid costly mistakes. For the sake of improving your long-term investment success you may just appreciate what another perspective can help you achieve.