The Trouble With Hindsight Bias

By Adam O'Dell  |  July 12, 2019

I’m going to show you a chart of a stock, and ask if you invested in a similar stock.

You don’t need to know the ticker of this stock to play this game. Just think of any initial public offering (IPO) you bought…

Any of the IPO’s you bought, which returned 6,870% in two years…

Any IPO you bought and held after being up 6,870% through a 94% crash — you’d still have been up 621%…

Any IPO you bought and held, even though the company wasn’t profitable for its first four years…

Any IPO you bought at inception and are still holding today for a 78,972% total return (not shown in the chart).

Here’s the chart:

Does this look familiar to you?

Now, what if I told you that you could’ve avoided the crash, but managed to get out with decent gains? There is a way, if you know how to work it

I Knew It All Along

Hindsight bias is an interesting “mental glitch” that affects investors and everyday folks alike.

It’s defined as: the inclination, after an event has occurred, to see the event as having been predictable, despite having been little objective basis, before the event occurred, for predicting it.

It’s also called the “knew-it-all-along effect” because that’s the tell-tale claim people will make when their memories and perceptions are under the influence of hindsight bias.

I’ve heard plenty of people claim after November 9, 2016, that they knew all along Trump would pull off a “surprise” win. None of these people were saying anything before November 9, 2016, though.

That’s hindsight bias.

I think it stems from two aspects of human nature: the comfort we find in stories and the discomfort we find in uncertainty.

Stories are comforting because they make us feel like everything in the world “makes sense.” If we can connect the dots — between A and B… and the story’s ending — we feel good that all is well and just.

Uncertainty is discomforting, well, for obvious reasons — it’s proof that we don’t know everything… that we can’t predict the future… and that we aren’t always as “in control of things” as we’d like to think we are.

Hindsight bias acts as a mental tool that quite effectively scratches both of these itches.

Hindsight Bias In Action

Think about Trump’s “surprise” win… A whole lot of people — even supporters, I think — were shocked at the result. The surprise reminded us we live in an uncertain world — a truth we find discomforting.

And so, hindsight bias crept into our minds, aiming to relieve our angst. Hindsight bias concocted plausible stories — with the benefit of hindsight, of course — about how it was “quite logical,” even “almost obvious,” how X, Y, and Z led to the environment in which a bombastic reality TV personality would pull off a “populist” presidential election win.

The hindsight stories of Trump’s win have grasped at anything that could make them sensical — populism, rural angst, progressive elitism, rust-belt neglect, income inequality, etc., etc.

To be clear, I’m making no judgments of Trump or voters. I’m only saying that many people have devised hindsight-bias-laden stories about the “surprise” win.

See, the thing with hindsight bias is that, in the end, all that matters is we walk away with the sense that whatever happened makes sense and wasn’t actually all that uncertain.

Resolving our discomfort with uncertainty is the key.

If we can convince ourselves that the past wasn’t actually as uncertain as we thought when we were surprised… we can assure ourselves that the future won’t be quite as uncertain as we’re concerned it may be.

Simply put: we become unjustifiably overconfident in our ability to foresee things, to avoid the discomfort of facing an incredibly uncertain future.

We fool ourselves — claiming to know then, with foresight, only what we know now, with hindsight.

The (Not So) Obvious Success of

Over just two decades, Jeff Bezos has turned (Nasdaq: AZMN) into the fourth most valuable company in the world.

In hindsight, the rise of Amazon seems almost obvious. You can order anything in the world from your couch and have it delivered to your door in two days, for free. Who can argue or compete with that?

It’s genius. And obviously quite lucrative now that Amazon has amassed such a following, with two-thirds of all U.S. households being Amazon Prime members.

But Amazon’s plan for world dominance wasn’t so obvious to investors — or even Jeff Bezos — back in 1997, when the IPO went live, or even in 2002 after it turned its first profit as an “online bookseller.”

No one really knew Bezos had ambitions beyond books and compact discs (CDs).

No one expected a decade of cheap oil to make home-delivery shipping so inexpensive.

No one foresaw how automated warehouse technology (aka “robot pickers”) would save Amazon millions in labor costs.

No one understood the impact that cloud-computing would have on online businesses.

And of course, no one knew just how relentless Bezos would be in massacring the brick-and-mortar’s, long-ago dethroning Walmart and, more recently, acquiring Whole Foods Market.

Though now — with the benefit of hindsight — we know all of these things and more. Looking backward, we can connect the dots and understand why Amazon is so popular and successful.

But don’t you dare say, “I knew it all along.” Because here’s the thing…

If you allow yourself to be tricked by the hindsight bias — believing you knew of Amazon’s potential all along, or at least that you could have known — you will become falsely overconfident in your ability to foresee the success of, and invest in, the “next Amazon.”

I hate to say it… but odds are, you probably won’t.

A Systematic Approach

I don’t have anything against stock-picking. I even do a fair share of it myself in Cycle 9 Alert. And soon I’ll be launching a new service, where I’ll be picking stocks in the high-growth cannabis industry.

What I do have an issue with is discretionary stock-picking… which I generally define as anything other than a systematic, rules-based approach to picking stocks.

One of the reasons for this is hindsight bias. It’s just too easy to read about Amazon’s success and then somehow feel confident enough to pick the “next Amazon” based on news stories or the company’s financial statements.

Unfortunately for most investors, that’s a fool’s errand.

A systematic approach to stock-picking is a surer way to long-term success. Even a simple trend-and-momentum system could have helped you get into Amazon’s stock early, despite not knowing a lot about the company’s fundamentals or eventual growth.

And while not every stock you approach this way will turn into an Amazon, all it takes is a few big winners like this to pad your account!

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Adam O'Dell

As Chief Investment Strategist for Dent Research, Adam O’Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with minimum risk. He achieves this with his perfect blend of technical and fundamental analysis.

Tactically, he does extensive back-testing and probability-based research. It’s the ultimate partner to the exhaustive research that Dent Research co-founders Harry Dent and Rodney Johnson do in the exciting realm of the new science of investing.

Adam is also the executive editor of our hugely successful trading services, Seven-Figure Trader, Cycle 9 Alert and 10X Profits.

He has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high-profit potential.

Aiming to find the best opportunities across all asset classes, Adam expanded into the commodities, equities and futures markets. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. MORE FROM AUTHOR