We are all subject to emotions, both positive and negative, which result from a multitude of factors such as our beliefs, experiences, worldview, and personality. Once you realize that your emotions can influence your financial decisions, you gain the ability to take a step back and develop a broader, more objective perspective.

By recognizing the most common behavioral patterns, you can optimize your investments and resist emotional pressures that could cloud your judgment. Let’s examine some cognitive biases that can impact our financial decisions.

● Confirmation Bias

Confirmation bias occurs when a person seeks information about a specific question but focuses only on the information that confirms their already-formed belief. This mechanism can lead to selective perception of information, where more importance is given to elements that support preconceived opinions while ignoring or minimizing those that contradict them.

Imagine an investor who firmly believes that the artificial intelligence (AI) industry is the key to the future and that investing massively in crypto-assets related to this technology is wise. This bias can lead them to deliberately seek information that confirms this conviction, such as positive articles about innovations in the AI field, recent successes of companies in the sector, or optimistic forecasts for the crypto-assets market.

At the same time, this investor may ignore or minimize contradictory information, such as warnings from experts about specific risks associated with this industry or critical analyses questioning the long-term viability of artificial intelligence.

Confirmation bias can lead to a skewed view of the AI-related crypto-assets market, as the investor only considers information that reinforces their initial beliefs. This may result in reckless investment decisions, as the individual may not be fully informed about potential risks or warning signs in the sector.

To mitigate confirmation bias, it is essential to actively seek information from diverse sources, consider opposing opinions, and regularly question one’s own beliefs. This more objective approach allows for more balanced and informed decision-making in the field of investment while reducing the potential impact of confirmation bias.

● Anchoring Bias

Anchoring bias appears when an investor receives initial information and interprets all new information based on that reference point.

Suppose you want to buy a new television. You walk into a store, and the first price you see is €2000 for a high-end model. This first piece of information, the “anchor,” can influence your perception of subsequent prices.

As you browse the store, you notice a second television priced at €1500 and a third one on sale for €1200. Due to anchoring bias, your brain may latch onto the first price you saw (€2000), leading you to perceive the €1500 television as a more affordable option and the €1200 model as an exceptional deal.

However, if you had started by seeing a basic model at €800, your perception of prices might have been different, and the €1500 television could seem relatively expensive. Anchoring bias can therefore influence how we evaluate and make decisions, using an initial reference (the anchor) as a comparison point.

In the context of crypto-assets, anchoring bias often appears when decisions are based on an asset’s past performance. For instance, an investor who reads that the price of a particular cryptocurrency they admire increased last year might draw shortcuts to justify their belief: if it was on the rise last year, it should rise again this year.

Hence the importance of taking regulatory warnings seriously: Past performance does not predict future performance! Also, seek reasons to invest in an asset based on its current situation and future market prospects.

To mitigate the effect of anchoring bias, it is essential to be aware of this cognitive tendency and actively consider other reference points when making decisions, rather than clinging too strongly to the first piece of information received.

● Activity Bias

Activity bias, also known as action bias, refers to the human tendency to prefer action over inaction, even when inaction could be the most rational decision. Investors suffering from this bias tend to act impulsively or make hasty decisions instead of taking the time to carefully evaluate the situation.

Imagine a crypto investor who, after a period of market volatility, observes a sudden drop in the price of a specific crypto-asset. Influenced by activity bias, they may be tempted to sell their holdings quickly, thinking immediate action is necessary to avoid further losses.

However, a more rational approach could involve a more thorough analysis of the situation, considering fundamental factors, market trends, and the long-term prospects of the asset in question. Activity bias can lead to impulsive decisions, such as hastily selling assets without taking the time to consider all relevant information.

To mitigate activity bias in the crypto-asset field, it is essential to develop a more thoughtful approach and make decisions based on thorough analysis rather than instinctive reactions. Understanding these cognitive biases can help you make more informed decisions and minimize the impact of impulsive emotional reactions on your investment portfolio.

● Risk Aversion

Risk aversion, in the context of investments, refers to an investor’s preference or tendency to avoid or minimize risks. People who are risk-averse are generally less willing to take financial risks, preferring safer investments even if it means potentially lower returns.

Risk aversion can have a paralyzing effect: the investor seeks to avoid any risk deemed too high. While it’s true that unnecessary risks should be avoided, excessive risk aversion will prevent you from implementing a strategy that could be fruitful for your portfolio.

Suppose an individual has the possibility to invest in two options: a stable investment offering modest returns and a riskier investment with high potential returns but also a higher probability of significant losses.

A highly risk-averse investor might choose the stable investment, even if the potential return is lower, because they prefer to minimize the risk of substantial losses, even if it means sacrificing some growth potential…

This text is an excerpt from the book “Investing in Cryptocurrencies” written by Eudes Djembo.

We invite you to read the following article “Dollar-Cost Averaging (DCA)”.

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