Heuristics is defined as "as a strategy that can be applied to a variety of problems and that usually, but not always, yields a correct solution. " Heuristics is like a simple shortcut for a complex problem. Unfortunately, by taking the short and easy road, the outcome will not always be positive. .
One important aspect of the debate about rational and irrational investors is the extent to which the most common errors made by investors is through their behavioral biases. Biases are judgments we make about people, policies, opportunities, and, in this case, the markets. Making an unbiased decision is essentially impossible and these biases at times may lead to unfortunate outcomes. In Investments Analysis and Management by Charles P. Jones, "behavioral finance analyzes behavioral biases and the effects these biases have on financial markets " According to Ritholz, columnist at the Washington Post, these are the investors' ten most common behavioral biases: confirmation bias, optimism bias, loss aversion, self-serving bias, the planning fallacy, choice paralysis, herding, ˜we prefer stories to analysis', recency bias, and the bias blind spot. .
Confirmation bias is somewhat of an abridged hypothesis-conclusion process. In other words, your hypothesis essentially becomes a conclusion and the person seeks facts that support pre-conceived notions. When the conclusion aligns with the factual background, this confirmation bias can be harmless. However, when people ignore facts that do not confirm their preconceived ideas, this can lead to negative outcomes. In the optimism bias the subjective thinking overcomes objective thinking. This bias causes a person to believe that they are less at risk of experiencing a negative event compared to others; hence, they are overly optimistic. On the other hand, loss aversion bias speaks to human's instinct to overemphasize loss and underemphasize the utility of gain.