We Misinterpret

THROUGHOUT THE DAY, whether we’re driving, catching up on our reading or sitting in a meeting, we’re bombarded with information. Most of the time, we do a decent job of making sense of it all—unless, that is, it’s financial information and especially market data.

We tend to read too much into the stock and bond markets’ short-term performance, sometimes extrapolating recent gains or losses, sometimes assuming there will be a rapid reversal. We’re sure we see patterns in price movements—and perhaps even a repeat of earlier market events—when, in truth, all we’re observing are random price changes.

We also give too much credence to anecdotal evidence and too little weight to statistics. We latch onto information that confirms what we already believe, which is why stock market bulls see only reasons for optimism and bears see only cause for worry. We’re overly influenced by information that’s easily recalled—not just plane crashes and shark attacks, but also hot fund managers and top-performing stocks.

This fuels our desire to make financial predictions. Faced with an uncertain financial world, we’re constantly trying to guess what will happen next. We may feel we foresaw earlier market developments—a phenomenon known as hindsight bias—and that makes us even more confident in our current predictions.

All this is dangerous. Instead of humbly accepting that we don’t know what will happen next in the economy and the markets, and hedging our bets with broad diversification, our predictions can lead us to make overly large investment bets. All too often, alas, that proves to be our undoing.

Next: We Hate Losing

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