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How to Avoid Survivorship Bias in Finance and Trading: A One-Minute Guide

 



Survivorship Bias Explained in One Minute: From Definition/Meaning to Examples (Finance and Trading)

Survivorship bias is a cognitive error that makes us overestimate the chances of success by focusing only on the winners and ignoring the losers. It can lead to false conclusions and poor decisions in many areas of life, especially in finance and trading. Here are some examples of how survivorship bias can affect your financial decisions:

How can you avoid survivorship bias in your financial decisions? Here are some tips:

  • Look for the whole picture: Do not rely on selective or incomplete data that only shows the positive outcomes. Try to find out the negative outcomes as well and compare them with the positive ones. For example, if you want to invest in a mutual fund, look at its performance over a long period of time and compare it with other funds in the same category.
  • Consider the alternative scenarios: Do not assume that the successful outcomes are the only possible ones. Try to imagine what could have gone wrong or differently for the survivors. For example, if you want to follow a successful trader, think about how their trades could have turned out badly or how they could have made different decisions.
  • Test your assumptions: Do not take the success stories at face value. Try to verify the facts and logic behind them and see if they still hold up. For example, if you want to copy a successful strategy, test it on historical or simulated data and see how it performs under various scenarios.

Survivorship bias is a common and dangerous mistake that can distort your perception of reality and make you overconfident in your financial decisions. By being aware of it and applying the tips above, you can improve your financial literacy and avoid costly errors. Remember, the savvy wallet is not only about making money, but also about keeping it.


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