BIAS 5 ILLUSION OF CONTROL BIAS BIAS DESCRIPTION

BIAS #5 ILLUSION OF CONTROL BIAS

BIAS DESCRIPTION The tendency of human beings to believe that they can control or at least influence outcomes when, in fact, they cannot. n People n feel as if they can exert more control over their environment than they actually can, n inferred causal connections where none existed, or n displayed surprisingly great certainty in their predictions for the outcomes of chance events. Expectancy of a personal success probability inappropriately higher than the objective probability would warrant. Where can we observe this bias

BIAS DESCRIPTION This bias can be observed in Las Vegas n n n People actually cast the dice more vigorously when they are trying to attain a higher number. Some people, when successful at trying to predict the outcome of a series of coin tosses, believe that they are “better guessers” Some claim that distractions might diminish their performance at this statistically arbitrary task n Task familiarity, competition, and active involvement can all inflate confidence and generate such illusions n People who were permitted to select their own numbers in a hypothetical lottery game were also willing to pay a higher price per ticket than subjects gambling on randomly assigned numbers

BIAS DESCRIPTION Hypothetical anecdote n Hypothetical anecdote: n In a small town called Smallville, a man marches to the town square every day at 6 P. M. carrying a checkered flag and a trumpet. When the man reaches an appointed spot, he brandishes the flag and blows a few notes on the trumpet. Then, he returns home to the delight of his family. n A police officer notices the man’s daily display and eventually asks: Officer: “What are you doing? ” Man: “Keeping the elephants away. ” Officer: “But there aren’t any elephants in Smallville” Man: “Well, then, I’m doing a fine job, aren’t I? ”

PRACTICAL APPLICATION “The Illusion of Control: What’s Luck Got to Do with It? ” (Breinholt and Dalrymple, 2004) n Two common impulses: the desire for control, and the belief in good luck as a controllable attribute. n Game: n All participants played 14 hands of “Red & Black, ” using four cards from a standard poker deck. n Each card was presented facedown on the screen, and subjects were asked to wager as to whether a chosen card matched a selected, target color. n The odds of winning each hand were calibrated at 50: 50.

PRACTICAL APPLICATIO n Participants randomly assigned to the high-involvement and low involvement condition. n The high-involvement condition was designed to maximize the participants’ perception that they were controlling the game. n n They were allowed to “shuffle” and “deal” the cards themselves. They could also choose, in each hand, the target color and the amount wagered. n In the low-involvement condition, the computer shuffled and dealt the cards. The participants chose the amounts wagered, but the computer randomly selected the card.

PRACTICAL APPLICATIO n The descending outcome sequence was designed to maximize the illusion of control, letting the majority of successful outcomes occur during the first seven trials. n The random outcome sequence was designed to minimize the illusion of control by spacing the successful outcomes more evenly over the course of the fourteen trials.

PRACTICAL APPLICATIO n Ultimately, participants in the high-involvement condition tended to wager more chips on each hand than participants in the lowinvolvement condition did. n Moreover, in the high involvement condition, high Distributed Feature Composition (DFC) participants wagered more than low DFC participants did. n In contrast, in the low-involvement condition, wagers did not differ reliably as a function of DFC. n In other words, participants receiving the descending sequence of outcomes did not wager more or less, on average, than did participants allotted the random outcome sequence. n This study clearly demonstrates the illusion-of-control bias. n Investors are very much susceptible to this bias.

IMPLICATIONS FOR INVESTORS Illusion of control bias can lead investors n to trade more than is prudent. n Researchers have found that traders, especially online traders, believe themselves to possess more control over the outcomes of their investments than they actually do. n to maintain underdiversified portfolios. n Researchers have found that investors hold concentrated positions because they gravitate toward companies over whose fate they feel some amount of control. This bias contributes, in general, to investor overconfidence.

RESEARCH REVIEW “Illusion of Control as a Source of Poor Diversification: An Experimental Approach” , Gerlinde Fellner (2004) n “Do individuals invest more in a “lottery” (stocks) for which they can control the chance move? ” n She hypothesized that the illusion of control bias accounts for systematic capital shifts toward investments (stocks) that offer investors the illusion of control. n Investors prefer to make investments over which they believe they can control the outcome.

DIAGNOSTIC TESTING Illusion of Control Bias Test Question 1: When you participate in games of chance that involve dice—such as Backgammon, Monopoly, or Craps—do you feel most in control when you roll the dice yourself? a) I feel more in control when I roll the dice. b) I am indifferent as to who rolls the dice. Question 2: When returns to your portfolio increase, to what do you mainly attribute this turn of events? a) The control that I’ve exercised over the outcome of my investments. b) Some combination of investment control and random chance. c) Completely random chance.

DIAGNOSTIC TESTING Illusion of Control Bias Test Question 3: When you are playing cards, are you usually most optimistic with respect to the outcome of a hand that you’ve dealt yourself? a) A better outcome will occur when I am controlling the dealing of the cards. b) It makes no difference to me who deals the cards. Question 4: When and if you purchase a lottery ticket, do you feel more encouraged, regarding your odds of winning, if you choose the number yourself rather than using a computer-generated number? a) I’m more likely to win if I control the numbers picked. b) It makes no difference to me how the numbers are chosen.

ADVICE 1. Recognize that successful investing is a probabilistic activity. n The first step on the road to recovery from illusion of control bias is to take a step back and realize how complex global capitalism actually is. Even the wisest investors have absolutely no control over the outcomes of the investments that they make. 2. Recognize and avoid circumstances that trigger susceptibility illusions of control. n Some correlations are arbitrary rather than causal. n n n Does the trumpet really keep the elephants away? Just because you have deliberately determined to purchase a stock, do you really control the fate of that stock? Don’t permit yourself to make financial decisions on what you can logically discern is an arbitrary basis.

ADVICE 3. Seek contrary viewpoints. Ask yourself: n n Why am I making this investment? What are the downside risks? When will I sell? What might go wrong? These important questions can help you to screen the logic behind a decision before implementing that decision. 4. One of the best ways to keep illusions of control at bay is to maintain records of your transactions, including reminders spelling out the rationale that underlie each trade. n Write down some of the important features of each investment that you make, and emphasize those attributes that you have determined to be in favor of the investment’s success.

FINAL THOUGHT n One of the best ways to prevent your biases from affecting your decisions is to keep the rational side of your brain engaged as often as possible. n Success in investing ultimately is found by investors who can conquer these daily psychological challenges and keep a longterm perspective in view at all times. n Keep track of your successes and failures.