We have been discussing the decision-making process neurologists have found to be the norm for humans.
We have seen that we use three processes:
- Pattern recognition
- Emotional Tagging and
- One-decision-at-time.
We have also seen that these processes work where the decision-maker has experience in the situation and type of decision to be made. Tonight, we look at where the processes may lead us astray:
Pattern Recognition
The two areas we need to exercise care are:
- Experiences which appear similar but are in fact different. The authors of Think Again call this misleading experiences. Because the experiences on which we rely to make our decision are substantially different to the present circumstance, we are likely to make a flawed judgement.
- Prejudgments. Our current decision is based on judgements already made. A great example of this is the heuristic of anchoring. An example of anchoring: we act based on where we entered our trade - rather than acting on present market information.
Tagging:
There are four areas we need to watch:
- Intense emotional experiences. We have powerful memories of successes and failures. But these emotional memories can mislead us because they are inappropriate to the current situation.
- Prejudgement. We imbue previous decisions with strong emotions. But if the judgements are misleading,our emotions can cause us to hold on to decisions long after the use-by date of the decision.
- Personal interests. Studies have shown that where our personal interests conflict with the reality of a situation, the resulting decision is often flawed. What we want and what is objectively available may be streets apart.
- Attachments. When we invest emotion on people, events or actions, the emotions so invested can cause distortion in our thinking. For example the heuristic of sunk costs: we already lost so much, we may as well hang on; the market must go our favour soon!
Tomorrow we’ll wrap up the series by seeing how the process applies to trading.
Refer this blog post to a friend or colleague…
