Cognitive Bias
A type of inaccuracy in thinking arises when people absorb and interpret information from the outside environment
What is cognitive bias?
Cognitive bias is a type of inaccuracy in thinking that arises when people absorb and interpret information from the outside environment. It has an impact on the decisions and judgments they make.
The brain tries to simplify information processing, which leads to cognitive biases. Biases are commonly employed as a guideline to help you make sense of the world and make quick judgments.
Rather than objective input, an individual's reality creation may influence their conduct in the world. As a result, it can occasionally lead to distorted perceptions, incorrect judgments, illogical interpretations, and irrationality in general.
Memory has a role in some prejudices. For various reasons, how you recall an experience might be skewed, leading to crooked thinking and decision-making.
Attention issues may be linked to other cognitive biases. Because attention is a finite resource, people must be careful in what they pay attention to in the world around them.
As a result, unconscious biases might influence how you view and think about the world.
Researchers Amos Tversky and Daniel Kahneman first established the notion of cognitive bias in 1972.
Since then, researchers have identified a variety of biases that affect decision-making in various fields, including social behavior, cognition, behavioral economics, education, management, health care, business, and finance.
What is the difference between cognitive bias and logical fallacy？
Because people may confuse it with a logical fallacy, it's essential to understand the differences between the two.
Errors in logical arguments lead to logical fallacies.
This results from flaws in thought processing, frequently produced by faults in memory, attention, attribution, and other mental processes.
Overconfidence Bias
Overconfidence bias tends to create inaccurate and misleading appraisals of one's skills, intelligence, or talents. Overconfidence might lead us to believe that our abilities, skills, or talents are superior to what they are.
It's a risky bias that's too typical in behavioral finance and the stock market.
Types of Overconfidence
The most common forms of prejudice are listed below.
1. Over Ranking
People overestimate their performance, and most believe they are better than average.
It can cause problems in business and finance because it usually leads to taking too much risk and, as a result, paying a high price.
2. Illusion of Control
When people believe they have more power than they do, this is known as the illusion of control bias. People think they have control over a problem even though they don't.
It is also incredibly risky in business or investing since it leads us to believe the situation is less complicated than it is. Inadequate risk management and the idea that one can handle hazards beyond one's capacity result from a failure to analyze risks appropriately.
3. Timing Optimism
Another facet of the psychology of Overconfidence is opportunistic optimism.
People, for example, overestimate how quickly they can complete a task while underestimating how long it would take them. People frequently underestimate how long it will take to accomplish a project, especially when it involves arduous duties.
Similarly, investors frequently underestimate the time it will take for an investment to pay off.
4. Desirability Effect
It is known as the desirability effect when people overestimate the likelihood of something happening solely because the outcome is desirable. It is frequently referred to as "wishful thinking" or an overconfident bias.
We believe a particular conclusion is more likely because it is the one we desire.
What are examples of Overconfidence?
Overconfidence can be displayed by someone who believes they have a greater sense of direction than they have.
For example, if he gets lost on a long journey without a map, he will not ask for directions and instead discover them on his own.
Why is Overconfidence important？
The overconfidence bias is one of the most potent and widespread cognitive biases. It tremendously impacts decision-making because our behaviors are determined by how we think about things.
We don't exaggerate our performance, assume we can control something we can't, overestimate the time we have to achieve anything, and don't manufacture wishful thinking when we realize it.
Self Serving Bias
A prevalent practice is a self-serving bias, in which a person takes credit for favorable occurrences or outcomes while blaming adverse events on outside forces.
Age, culture, clinical diagnosis, and other factors can influence it.
In most populations, self-serving bias is expected.
What are examples of Self-Serving Bias?
Some examples are:
1. Self-serving bias in the workplace
In the workplace, there are numerous examples of selfish bias.
Candidates felt they were hired because of their accomplishments, qualifications, and great interviews. He often claims that the interviewer dislikes him when he isn't hired after an interview.
Furthermore, egocentric bias is especially prevalent in instances involving negative results. The farther away an employee is from their coworkers. The more likely their coworkers are to blame each other for workplace failures.
On the other hand, employees who are closer to their coworkers are less prone to blame each other for workplace mistakes.
2. Self-serving bias in sports
If you've ever played or seen an individual sport, you might blame a bad call on the referee or the other team for cheating when you lose a game, but when you win, you might celebrate your talent and mental toughness.
Self-serving bias is widespread in team sports. For example, athletes may attribute victory to their hard work and training when they win a race. They blame the referee or their teammates when they lose.
Why is Self-serving bias important？
Selfish biases have a significant impact on many facets of our life.
Egocentric biases frequently influence how well we perform in school, in our employment, in sports, and so on.
Knowing what causes our personal and professional triumphs and failures can allow us to learn from our mistakes and develop.
We can avoid self-serving bias and make better choices and decisions if we comprehend the self-serving bias.
Herd Mentality
Herd psychology refers to people's inclination to imitate or repeat the actions of others. Rather than their independent analysis, they are driven mainly by emotion and instinct.
In the nineteenth century, social psychologists Gabriel Thade and Gustav Le Bon pioneered the concept of the "group mind."
What are examples of Herd Mentality?
Some examples are:
1. Herd Mentality in choosing a restaurant
Let's pretend you're on vacation and need to find a restaurant in an unfamiliar city. There are two Chinese restaurants across the street at night.
There was no one at the door of one restaurant, whereas the other had many customers.
Which restaurant do you intend to visit? Which of the following do you prefer: One restaurant was packed with many customers, whereas the other had very few.
The majority of individuals prefer a crowded restaurant to one that is deserted.
While some people may conclude that busier restaurants serve excellent food (which may or may not be true), others simply make their own decisions based on what they see others doing.
2. Herd Mentality in the financial market
Herd mentality can also affect finance. Typically, investors purchase stocks to follow the actions of others.
You might invest in a stock after reading an expert commentary or hearing news about what you believe will be the next great thing.
Because you believe everyone else is buying it, you think you'll be missing out on a significant opportunity if you don't.
A real-life example is the dot-com bubble. People invest in technology stocks because they see their peers doing so. Rather than relying on rigorous analysis to make a stock buying choice,
Why is Herd Mentality important？
We consciously avoid automating our thinking when we comprehend the Herd Mentality so that when we make a decision, we can spend a bit extra time rather than rushing to a conclusion.
Accept, at the same time, that you will occasionally be different from the rest of the group. Also, instead of attempting to please others, be honest with yourself when dealing with others.
Loss Aversion
Loss aversion is a cognitive bias that explains why a psychological loss is twice as painful for a person as the pleasure obtained. Losing money or something of value is more painful than getting it.
In a 1979 work on subjective probability, Daniel Kahneman and his colleague Amos Tversky invented the phrase "loss aversion."
What are examples of Loss Aversion?
Loss aversion presents itself in everyday life as risk aversion.
For example, if someone gives us a $300 bus pass, we may experience a modest degree of enjoyment.
We will be even less pleased if we lose our bus card, which has a balance of $300.
This discontent is stronger than the joy we get when we receive a bus pass.
How is loss aversion different from risk aversion?
Everyone's risk tolerance is different. It is determined by personal assets and income, the investment period (such as retirement), age, and other factors.
Risk-averse people are less likely to take risks than those who seek them out.
On the other hand, risk aversion is entirely reasonable because losses and gains are considered symmetrical at any degree of risk.
Loss aversion asserts that losses are more concerning than gains at whatever level of risk tolerance and that this extreme aversion to losses is irrational.
Why is Loss Aversion important？
It's important due to:
1. It assists you in making investments
It enables us to comprehend that the brain's judgments are influenced not only by reason but also by emotional, more primal areas of our brains. We can make better investments if we recognize this.
2. It aids in the avoidance of the sunk cost fallacy
For example, someone may buy an automobile on impulse that isn't very good, but because they've already paid for it, they continue to pay to keep it running even if it would be better to sell it.
3. It aids in the evaluation of consumer behavior
Loss aversion can explain people's behavior toward price hikes, free trials, limited-time offers, and price decreases, among other things.
Framing Cognitive Bias
The framing effect occurs when the way information is presented influences our decisions. The person may react to the data according to the positive and negative lead to make a decision.
For example, the person may be more inclined to favor a salesperson when the salesman highlights only the product's positive features and omits the negatives.
The customer may become skeptical or take a back if the salesman highlights more negatives than positives of the product.
The highlighted elements can make equivalent information more or less appealing.
Types of Framing Cognitive Bias
Some types are:
- Auditory frame: The auditory framing is simple to understand. When faced with two options, how the question is posed significantly impacts our decision.
- Visual frame: Color, images, text size, font style, and even body language are all examples of visual frames. Color, for example, can have a significant impact because each color indicates a different set of traits.
- Value frame: Value framing uses psychological tactics to make us believe we are getting a better deal or offer than we are. Higher value, for example, helps us think it's a better deal.
- Positive and Negative Frames: "Don't miss it," for example. The framework is straightforward, yet it appears that have lost something.
What are examples of Framing Cognitive Bias?
Consider the following two contribution systems, each of which may save 600 children:
Plan A would save 200 persons in the first scenario. Plan B has a one-in-three probability of rescuing 600 people or none at all.
Plan A would kill 400 people in the second scenario. Program B has a one-in-three likelihood of no one dying and a one-in-600 chance of 600 people dying.
According to prospect theory and the framing effect in psychology, people would choose A in the first group and B in the second. However, both frames are logically equal once again.
Why is Framing Cognitive Bias important？
When people are unsure of all the information or when there are numerous unknown variables, they are more likely to make automated decisions. As a result, the likelihood of being affected by frame bias rises. They may avoid it once they understand the principle.
Narrative Fallacy
The so-called narrative fallacy is one of the limitations of our ability to evaluate information objectively.
We have a strong desire for fantastic stories and let that desire cloud fact and our capacity to make sensible judgments. It means we could be led to a less-than-ideal solution merely because it has a more compelling tale.
What are examples of Narrative Fallacy?
Some examples are:
- Example 1: Some people think history is a series of unavoidable occurrences rather than a chemical reaction of influences and characters along the road. Why is it so difficult to foresee the future if the past is so easy to predict with hindsight?
- Example 2: The rise and decline of firms are described in management literature, with crucial decisions, lordship styles, and the founders' childhood attributes being blamed for their success. These accounts disregard the other factors that could have contributed to the company's failure.
Why Do We Love Narratives and Fall into the Narrative Fallacy?
What is it about stories that make us fall in love with them? Reports frequently contain emotional information that taps into our subconscious or reflexive reasoning. Because they include an emotional component, stories are easier to recall.
Teachers, likewise, frequently employ anecdotes in their presentations to students. They do this because they know that this will help kids remember and recall the content in the story.
Why is Narrative Fallacy important？
The problem with stories is that they can potentially influence our thinking negatively. Let's put logic aside and focus on fantastic storytelling instead.
We need to comprehend this vital notion because when we fall into the narrative fallacy, our learning is limited, and we label things instead of focusing on facts.
Similarly, we must avoid narrative fallacies in financial markets, which can lead to irrational actions.
Anchoring Bias
Anchoring bias is a cognitive bias in which we place too much emphasis on the first piece of information we hear about a topic.
We interpret updated information from the anchor's reference point when making plans or projections rather than looking at it objectively.
If you see a $200 pair of sneakers and then a $100 couple, it's tempting to think the second pair is cheap.
However, if you only saw the second sneaker, you may not assume it was inexpensive.
The first price you see is the anchor, which will undue influence your decision.
What are examples of Anchoring Bias?
The most expensive and attractive cars are shown first in showrooms to persuade people to buy them. Customers will not only be attracted, but they will also be able to view the highest price point first.
Customers may notice the most costly phone, which is out of their price range yet anchored when they go in. Every other price appears to be less expensive in comparison.
In contrast, the higher the anchor point's price, the more people are ready to pay.
To entice consumers to buy them, the most expensive and attractive cars are frequently shown first in showrooms. Customers will not only be drawn in, but they will also have first access to the highest pricing point.
When customers enter, they may discover the most expensive phone, which is not in their price range but is anchored. In comparison, every other pricing appears to be less expensive.
The higher the price of the anchor point, on the other hand, the greater the willingness to pay.
Why is Anchoring Bias important？
Anchoring bias benefits decision-making because it allows us to generate reasonable estimates with limited data.
Your anchoring bias influences the amount you're willing to spend. It could also have an impact on your pay discussions. It is far more than that, and its impact is far more significant than money.
For example, at what age should you own your own home?
You were taught that people should start working after college and think about owning their own homes. The anchoring effect makes you believe that buying a house soon after graduation is expected.
Confirmation Bias
Confirmation bias is the tendency to process information by seeking or interpreting data that supports one's pre-existing opinions.
Types of Confirmation Bias
Some types are:
- Biased Search for Information: The overwhelming search for evidence to support a hypothesis or idea is explained by confirmation bias.
- Biased Interpretation: People frequently compare confirmatory evidence to evidence that does not contradict their ideas, interpreting proof in light of their views.
- Biased Memory: People may selectively remember/recall information to confirm their existing opinions. Memory bias is defined differently by different psychological theories.
What are examples of Confirmation Bias?
Some examples are:
1. Confirmation Bias in religion
Religious people have prejudices against those who do not share their beliefs. Because God exists, anything unexpected that occurs is a miracle.
People who aren't religious, on the other hand, exist. Miracles are considered one-of-a-kind occurrences that do not demonstrate the existence of a higher power.
At the same time, disasters like tsunamis and hurricanes, which killed thousands of people, are interpreted as proof that God isn't looking out for us.
Events are frequently used by believers and non-believers alike to prove their existing beliefs. Regardless of how favorable or unpleasant these events are, they serve to reaffirm these ideas.
2. Confirmation Bias in social media
Misinformation has proliferated on social media. People are likelier to "share" information or news pieces that confirm their preconceived notions.
Some news items claim to be "facts," although they are biased opinions based on the readers' experiences. These "facts" merely confirm what people already believe.
Why is Confirmation Bias important?
Confirmation bias is essential because it can lead people to adhere to incorrect views or prioritize information that confirms their opinions over evidence.
It impacts not only how we gather data but also how we understand and recall it.
Recognizing confirmation bias is critical, especially in the present Internet age, when individuals are continuously bombarded with more data than ever.
Confirmation bias can influence how you see the world. It can affect everything from political opinions to workplace hiring practices.
Hindsight Bias
Our inclination to look back on an unpredictable event and believe it was easy to predict is known as the hindsight bias. The "always know" effect is another name for this phenomenon.
For example, we tend to overestimate our capacity to predict the outcome of an experiment, a sporting event, a military action, or a political election.
What are examples of Hindsight Bias?
One person, for example, believes that X Company is a smart buy at $5 per share.
The company sells phones and appears to be profitable, so that it could be a decent investment.
However, he was hesitant to invest in the company since he was dubious about it.
When the stock hit $10 a share a year later.
Then he said that he predicted that they would rise.
How to Prevent Hindsight Bias?
To avoid hindsight bias, acknowledge that we can't anticipate the future and rely on data to assist us in making informed decisions.
Taking thorough notes or documenting the decision-making process can help with this.
Reasons, as well as any hunch or emotional components, may be included in these notes.
Why is Hindsight Bias important?
Errors in data processing and analysis can be caused by hindsight.
These errors can lead to illogical judgments, resulting in unfavorable or harmful investment or company outcomes.
These poor decisions can lead to financial losses, resource misuse, and other issues.
Representativeness Heuristic
When people are confused about the probability of an outcome due to the similarity of objects or events, representational heuristic bias emerges.
When attempting to determine the possibility of an event occurring, we frequently base our judgments on how similar it is to existing mental archetypes.
People frequently believe that two similar occurrences or events are closer together than they are.
We utilize it as a mental shortcut to evaluate probability.
What are examples of the Representativeness Heuristic?
Consider the following situation:
Mike. He's 25, single, outspoken, and intelligent. In college, he majored in economics. As a child, he was very fond of sports, especially basketball.
For example, is Mike more likely to work in a bank? Or do you think he'll work in a bank and play basketball?
Many respondents chose the second option; Mike works in a bank but is also a basketball player.
However, this is not the case. When they gave this answer, they were subject to representative heuristic bias.
One thing to remember is that you should evaluate things solely based on statistics or reasoning, not just based on their existence.
The probability that Mike works in a bank and is also a basketball player is lower than the probability that Mike only works in a bank. So Mike is more likely to only work in a bank.
Why is the Representativeness Heuristic important？
Representational heuristics are ubiquitous and can influence a wide range of real-world decisions and judgments. It frequently results in poor judgment, which can have catastrophic implications.
Representativeness heuristics can cause problems in criminal justice, health care, interpersonal attitudes, and stereotypes.
Cognitive Bias FAQs
There are numerous advantages to it.
Individually, for example, can assist people in making the best decisions when faced with ambiguity.
Similarly, it can motivate people to help one another in a group setting.
It can undermine your decision-making ability, limit your ability to solve problems, hinder your professional performance, degrade your memory's reliability, challenge your ability to react in crises, increase anxiety and despair, and harm your relationships.
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