The Un- Familiarity Bias

Photo by Martin Wilner on Unsplash

What is a Psychological Bias

Also known as Cognitive Bias, Psychological Bias is the tendency to make decisions or to take action in an unknowingly irrational way. For example, you might subconsciously make selective use of data, or you might feel pressured to make a decision by powerful colleagues. (read more)

Charles Schwab Corporation. (September 8, 2020). Most frequent client biases seen by financial advisors worldwide in 2019 and 2020 [Graph]. In Statista. Retrieved January 02, 2022, from https://www.statista.com/statistics/936127/financial-advisors-biases-among-investment-clients/

What is Familiarity Bias

The bias we will highlight in this write up is related to the “familiarity bias”. Familiarity Bias is the tendency of overweighting belief to ideas, instances or events you are already familiar with. According to Charles Schwab Corporation 27% of the respondents showed signs of Familiarity Bias in the calendar year 2020.

The feeling that tells you something is about to happen because you recall something similar that had happened and you feel it’s a hunch, that might be you on the verge of making a psychologically biased decision.

We realized while there was a-lot of scholarly articles and journals available on this, there existed a similar bias converse to this which was not very spoken off. The aversion to something you are not familiar with, while people herd around familiar instances the opposite is also true. Implying people move away from things they do not understand.

The Opportunity

Recently many companies were listed with no comparable peer and a lack of past performance ensured only a few analysts were tracking them. Most of which were just making commentary reports lagging the market performance. On recognizing the anomaly our team did a analysis in the past and we noticed many of such “lets stay away from what we do not understand” companies or sectors were major wealth creators.

This strategy sets perfectly in line with Warren Buffett’s famous quote of buying the fear and selling the greed.

Most recent stocks are barely covered and tracked by analysts or institutions which means high probability of over reaction to surprise (and shocks) because these stories are not yet fully understood by the market their prices have not yet really been inflated.
Most of such companies would show absurd financial metrics and hence would not be tracked by the free screeners available online, in-fact for most of these the old financial metrics might not even be the correct metric.

The above factors contribute to the stocks of the company only being held by fewer, stronger hands implying lack of supply and market noise each of which would make them extremely sticky to the stock trend.

A major issue with companies which have remained listed for many years is most of these companies would eventually have analysts and institutions who track and know almost all possible triggers for the companies, hence almost all information would be priced in squeezing out any probability of alpha, while in the case of these newer listings, spinoffs or demerged entity the future probability of any such major institution becoming a buyer would create alpha due to sudden demand

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Leveraging Research and Data Science to create actionable investing strategies in the stock markets. All posts are educational | more on www.cravingalpha.com

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Craving Alpha

Craving Alpha

Leveraging Research and Data Science to create actionable investing strategies in the stock markets. All posts are educational | more on www.cravingalpha.com

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