Friday, November 2, 2012

Are you susceptible to the ‘backfire effect’?

Before I explain what the ‘backfire effect’ is (please be reassured that it has nothing to do with a badly tuned two or four wheeler) and why you should or should not be susceptible to it, please allow me a little digression.

Before I started writing this blog more than 4 years back, I used to be a regular visitor and participant in various online investment groups. My altruistic objective was to leverage more than 2 decades of investing experience to spread knowledge and awareness among young, novice investors.

The bull run was continuing unabated, and most discussions in various investment groups were about unknown or questionable companies whose stock prices had already zoomed up to unreasonable levels.

Since this was a tell-tale sign of a bull market nearing its peak, I cautioned investors by posting contrary fundamental and technical opinions about some of the companies being discussed. Surprisingly, most responses to my posts ranged from the indignant (“I will buy more if the stock price falls”) to the downright offensive (“Don’t spread stupid rumours”).

In one of the groups, I had posted in Oct ‘07 that the Sensex was looking extremely overbought technically and investors should book profits. In those days, many small investors were unconvinced about the efficacy of technical analysis. Many still are.

There was a hue and cry among group members and I was banned from the group for my heresy. It opened my eyes, and taught me that it is very difficult to convince some one in an argument if a strong opinion has already been formed.

That brings me to the ‘backfire effect’, that most human beings are susceptible to and can prove disastrous in investing. This is how Wikipedia describes it: (It) is a cognitive bias that causes individuals challenged with evidence contradictory to their beliefs to reject the evidence and instead become an even firmer supporter of the initial belief.

In a recent discussion in an investment group, the topic of discussion was a tea producing company that had entered into an agreement with an overseas company for training and maintenance of flight simulators, and had also launched a chain of ‘kebab’ outlets. I questioned the di’worse’ification because of the lack of synergy between the three businesses.

I shouldn’t have bothered. The response was predictable. The investor who had initiated the thread posted that he loved di’worse’ified companies, and would add more to his substantial holdings if the stock price dropped. A classic case of the ‘backfire effect’!

Related Posts

About Confirmation Bias in the Stock Market
Are you emotional or logical in your investment decisions?

2 comments:

Eswar Santhosh said...

Honest answer would be: Yes! sometimes.

Despite one's best efforts, we are hard wired to search for views that cement our point of view rather than against it. It's hard to be free of all biases at all times. We might recognize a few of them very late, at times only with the benefit of hindsight. We cannot try and become a machine without emotions, but we can bring ourselves to act firmly once we recognize an unneeded trait.

A George Soros quote:

"On the abstract level, I have turned the belief in my own fallibility into the cornerstone of an elaborate philosophy. On a personal level, I am a very critical person who looks for defects in myself as well as in others. But, being so critical, I am also quite forgiving. I couldn't recognize my mistakes if I couldn't forgive myself. To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes."

Subhankar said...

We all have our beliefs and biases, Eswar. The trick is to be aware of them.

Belief in one's own fallibility comes with age and experience. The confidence of youth gets replaced by circumspection.