Certain distortions in thinking can lead to decisions becoming inaccurate or irrational. Such biases also play a role in connection with the stock market and trading. One example of this is survivorship bias. In this article, you will find out exactly what survivorship bias means and what it can lead to.
What does survivorship bias mean?
With so-called cognitive distortions are phenomena from cognitive psychology. It is about faulty tendencies in perception, thinking, remembering and judgment. These can lead to irrational decisions.
Survivorship bias means something like "Survivor bias". These distortions are particularly easy to observe when data sets of samples only contain "surviving" observations. Examples that were not successful are not taken into account, which leads to Misjudgements can lead to.
The fact that Failures not sufficiently taken into account In particular, the probability of success of groups, individuals or certain events can be overestimated. Successes are therefore seen as an effortless ascent without taking into account the entire process, which also includes setbacks and difficulties.
This bias also plays an important role in the context of the stock market: many investors are guided by past successes, for example, but ignore previous losses, which leads to unrealistic expectations of their investment leads.
Why does survivorship bias arise?
Basically, perceptual errors or cognitive distortions arise because the human brain Abbreviations are used. These are intended to simplify things and make ways of thinking more efficient and are also called "Heuristics" called.
- This works by people drawing on past experiences when thinking
- However, this also leads to problems such as the formation of typical prejudices or stereotypes and stereotypical thinking
Survivorship bias can arise as part of an analysis if the data used is selected incorrectly. In this case, the focus of the observer is largely on past successes without sufficient consideration being given to failures. The Errors can occur in one of the following three process steps:
It can be used as early as the Data collection problems can arise. If failures are consciously or unconsciously excluded, there is a strong focus on previous successes.
Also in the course of the Data preparation difficulties can arise if part of the data collected is excluded and the remaining data largely contains successes.
In some cases, the error only occurs during the Analysis. Although sufficient data is available, a person can only focus on a certain type of data, in this case specifically on past successes. This makes the interpretation irrational and unrealistic due to the focus on successes, as the failures have not been taken into account.
Survivorship bias on the stock market
Below we look at specific examples of survivorship bias as it can arise in the context of the stock market and investing.
Growth stocks
One way to observe the survivorship bias in concrete terms is to trade in growth stocks. During good economic times, growth stocks are often very popular with investors. Investors assume high growth potential and share prices. However, such company shares can often only no or low profits to show.
Investors who are increasingly focusing on Growth stocks often justify their investments with past success stories of former growth stocks. These have exceeded all expectations and generated high profits.
The survivorship bias is clearly recognizable here: investors take past successes into account, but ignore failures and failed growth stocks. This leads to unrealistic future forecasts and expectations.
Investment Fund
In the course of performance analyses of Investment Fund this can lead to survivorship bias. When the performance of funds is considered, often only the funds that have actually survived are included and were not closed. Funds that have underperformed are also often not included.
The fact that such failures are not even taken into account in the data set leads to a misjudgement of the performance of funds. The Overall performance can thereby estimated unrealistically high while the possibility of failure is ignored.
Indexes
When indices are considered, the companies included are often considered to be of high qualityas they must already have fulfilled certain criteria in order to be included in the index.
However, indices are revised at regular intervals. Again and again companies fall out of indicesthat can no longer meet certain criteria. They are replaced by other companies that can move up instead. Only a few shares that have fallen out of an index manage to be included again at a later date.
How can investors prevent survivorship bias on the stock market?
In the context of investments, survivorship bias can lead to irrational transactions and thus to Losses lead to a distortion. It is therefore crucial for investors to understand this bias and take it into account in everyday life. But how can this be done?
You can find possible distortions if you not only look at the data you already have, but also ask yourself what could be missing. Do you have sufficient data available? Are poor key figures and negative developments also taken into account and is the data representative?
In addition, past success stories should always be scrutinized and set in relation to the total number. Are these successes very common in the industry in question or are they the exception rather than the rule?
One concrete strategy is the Systematized investing. Here, investors use fixed sets of rules to make their investment decisions. They are not impressed by past successes and instead rely on predetermined rules to make it more difficult for distortions to occur.
A sufficient Risk Management is one of them. One example Fundamental analysesthat take concrete figures into account and are not just based on the past of a company or an industry.
Conclusion: Survivorship bias in investing
Cognitive distortions play an important role in everyday life. Erroneous tendencies can arise in relation to thinking, perception, remembering or judgment. An impressive example of this is the survivorship bias, in which people only focus on successes and do not take sufficient account of failureswhich leads to unrealistic and incorrect estimates.
Such distortions also play an important role for investors on the stock market. For example, some investors prefer to buy growth stocks based on the outstanding success stories of a few companies. The failures of a large number of other companies are ignored.
If investors are influenced by survivorship bias, this can lead to irrational assessments and the associated losses come. A better understanding of cognitive bias can therefore help to optimize one's own investment decisions. This can be achieved, for example, by using fundamental analysis and systematic investing to reduce such risks.