Our conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance. - Daniel Kahneman

Overconfidence

The intelligent people are full of doubts while the stupid ones are full of confidence.

 

Overconfidence is the bias in which someone's confidence in his/her judgement is larger than the objective accuracy of the judgement. Overconfidence increases with expertise: experts are more overconfident than laypeople. For instance, in a classic study, 94% of professors claimed to be better than the average professor. In investing, investment advisers think they are better at picking winning stocks than they are in reality. However, a vast majority of professional stock pickers are not able to beat the market (and are actually worse than the reference index). Overconfidence also is the main reason why most stock market guru's get wiped out over time. The most famous example is Long-Term Capital Management, a hedge fund founded by several Nobel prize winning professors in economics.

Loss Aversion

Watering the weeds and cutting the flowers.

 

People prefer avoiding losses than acquiring gains. E.g. most people will prefer avoiding losing $10 over a potential win of $10. In investing, people will hang on to a losing stock, in the hope that it will recover, rather than taking their loss by selling the stock and reinvest in a potential winner. Peter Lynch has called this "watering the weeds and cutting the flowers". You don't need to be a professional gardener to realize this is not exactly a winning strategy.

Causality bias

Causality is only a metaphor of knowledge, with which we explain things to ourselves.

 

When two things happen together, we automatically assume that one caused the other. In investing, every day the newspapers are filled with reasons why the stock market moved up or down, without any scientific proof that those were really the causes. In reality the prices of stocks go up and down for so many reasons it is too complex for humans to understand. Apparently, most professionals cannot resist the urge to explain day-to-day changes instead of focusing on the long term.