What Your Grade-School Science Fair Can Teach You About Investing

You've probably been doing research wrong...

When you need to answer a question – whether about investing or life – you probably start by looking for more information. That's the typical first step.

But it's also where many folks run into trouble.

You see, it's natural to seek out data that supports your hypothesis... And you likely don't even notice you're doing it. We all want to prove ourselves right. This is called "confirmation bias."

Said another way, there's so much information out there that we can easily confirm what we already think (no matter what it is).

This is a surefire way to lose your shirt in the markets.

Confirmation bias is a tricky phenomenon. So you might think it calls for a complex solution. In fact, you probably already learned how to fight it... all the way back in elementary school.

The scientific method has been a mainstay of early education for decades. If you need a refresher, this simple system is widely considered the proper way to objectively take in new information.

It has five basic steps...

1. Make an observation
2. Ask a question
3. Form a hypothesis
4. Test your hypothesis
5. Analyze your data and draw a conclusion

This process can be used for everything from elementary school science fairs to PhD-level research – and it's an extremely useful tool in disciplined investing.

Confirmation bias comes into play in Step 4. If you only look at your side of the problem, you'll be misguided.

To use the scientific method the right way, try to prove yourself wrong...

In the 1930s, a philosopher of science named Karl Popper argued that proving an "affirmative theory" wasn't enough.

To be truly objective, you have to play "devil's advocate" with your own beliefs. Most of the mainstream media just doesn't make that effort. And neither do poor investors.

Consider the popular idea that we're on the edge of a recession. The talking heads are certain that the world is going to shambles... that the markets are all entering a massive bear market... and that we're in a recessionary pullback.

There's plenty of data to back it up – assuming that's all you look for. So once the media and the attention-seekers come up with that hypothesis, it's easy to justify it. Harvard Business School Professor Max Bazerman calls this the "confirmation trap."

But as we've explained, these so-called "experts" are ignoring plenty of positive market signals. They're only interested in data that backs up their recession theory.

This is the problem.

At Altimetry, we play devil's advocate as part of our investment process...

Once we have a long idea in mind, our team assigns someone to represent the opposite side. This person purposefully raises everything that could go wrong with our stock idea. He says out loud what could otherwise be considered impolite.

If he makes a strong enough case for the downside outweighing the upside – or even simply removes any comfortable cushion in our analysis – then we have to do more research or pass on it.

Think about the last time you got angry...

Anger distorts our reasoning. When you're mad, you tend to find reasons to back up that anger... whether it's about an argument in a romantic relationship or your kids not listening to your advice. Even the smallest molehill can seem like a mountain if you're already determined to be mad.

When you do this, you're following the same confirmation bias that can trip up your investments.

The stock market doesn't care about your emotions. And it certainly doesn't care about your undisciplined research. No amount of conviction will make your wrong ideas right simply because you want them to be.

Even when stocks fall and folks lose money, they often refuse to give up. They dig in their heels and blame the market for being irrational... or rigged... or they say it's the Federal Reserve's fault.

In reality, when the market moves against you, it's almost always because of an error in your approach. There's always a clue that the stock could do the opposite of what you expected.

When we lose money, it's likely because we failed to apply the scientific method properly. We sought data to confirm our feelings, rather than to confirm the truth.

Wishing you love, joy, and peace,

Joel
September 9, 2022