Cognitive Information Perception & Processing

How We Process Financial Information

Investors don't process financial information like computers. Our brains use mental shortcuts, filters, and distortions that systematically bias how we perceive and interpret market data.

Investors face three key challenges:

1. Attention: What information do we notice vs ignore?
2. Interpretation: How do we make sense of information?
3. Memory: What do we remember when making decisions?

Attention Biases: What We Notice

Salience Bias: Vivid, dramatic information captures attention while boring but important data gets ignored.

Examples:

• Stock market crash (vivid) vs gradual 15% annual gains (boring but valuable)
• Company scandal headlines vs quarterly earnings improving steadily
• Friend's crypto jackpot vs most crypto investors losing money

Recency Bias: Recent events dominate attention, overshadowing long-term patterns.

• Market up last 3 months → "Bulls forever!"
• Market down last month → "Crash imminent!"

Confirmation Attention: We notice information confirming our beliefs, filter out contradictions.

• Bullish on Tesla → Notice every positive Tesla story
• Miss negative news or dismiss it as "hit pieces"

Interpretation Biases: Making Sense of Data

Same information, radically different interpretations based on cognitive framing:

Representativeness in Interpretation:

When analyzing company performance, we judge by similarity to prototypes:

• "Young charismatic CEO like Jobs → Next Apple!"
• Reality check: Most companies with charismatic CEOs fail

Anchoring in Interpretation:

• Stock was ₹1,000 last year, now ₹600
• Interpret as "cheap" anchored on ₹1,000
• Reality: Maybe fundamentals deteriorated, ₹600 is fair/overvalued

Memory Biases: What We Recall

Availability Heuristic: Easily recalled events seem more probable than they actually are.

• Vivid 2008 crash → Overestimate crash probability
• Media coverage of outliers → Think they're common
• Friend's winning stock pick → Ignore their many losers

Peak-End Rule: Remember extreme moments and final outcomes, not the full experience.

• Remember portfolio's highest value and current value
• Forget the long middle period of steady growth
• Makes volatility seem worse than it is

Hindsight Bias: Misremember our past predictions after seeing outcomes.

• After 2020 COVID crash recovery: "I knew that would happen!"
• Reality: You were panicking like everyone else
• Prevents learning because you think you already knew

Real-World Impact

Dotcom Bubble (1999-2000):

Cognitive distortions created largest bubble in history:

• Attention: Focused on sexy internet stories, ignored P/E ratios of 100+
• Interpretation: "This time is different, old valuation metrics don't apply"
• Memory: Recalled only success stories (Amazon early investors), forgot failures

Result: $5 trillion wealth destruction when reality corrected perceptions.

COVID-19 Market (2020):

Same information, opposite reactions:

March:

• Attention → Virus death tolls (salient)
• Interpretation → Great Depression 2.0
• Memory → 2008 crash felt imminent
• Action → Panic sell

April-May:

• Attention → Vaccine progress, stimulus
• Interpretation → Recovery ahead
• Memory → "Why did I panic sell?"
• Action → FOMO buy

Behavioral investors who recognized their biases:

• Stayed invested through March (rational: valuations attractive, vaccines likely within 18 months)
• Gained 50%+ by not letting fear distort perception

Debiasing Strategies

For Attention:

• Use checklists to force attention to fundamentals
• Set calendar reminders for diversification review
• Follow quantitative screens, not headlines

For Interpretation:

• Seek "steel man" arguments (strongest form of opposing view)
• Use outside view: "What typically happens in situations like this?"
• Question emotional interpretations: "Am I seeing this clearly?"

For Memory:

• Keep investment journal with original rationale
• Review past decisions with actual data, not reconstructed memory
• Use objective performance tracking (don't rely on recall)

Key Insights

• Perception ≠ Reality: We see markets through biased cognitive filters
• Salience dominates: Vivid information captures attention unfairly
• Framing matters: Same data, opposite interpretations based on cognitive frame
• Memory rewrites: We misremember predictions, preventing real learning
• Combat biases: Checklists, outside view, written records help

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