Heuristics
Candlefocus EditorHeuristics has become an important tool in the area of behavioural economics to enable investors and financial professionals make investment decisions quickly. This approach can lead to decisions being taken based on limited data sets, however, the speed in which decisions are made can be a compensating factor. In certain cases, the time taken to make detailed research can lead to a missed opportunity.
The advantages of heuristics can be summarised as follows:
1) It is an intuitive ‘gut’ approach to problem solving that can be used to make a decision quickly;
2) It can lead to efficient and effective solutions to investment and financial problems;
3) It can be used to utilise limited data sets for making decisions; and
4) It can help investors take advantage of opportunities that can arise suddenly.
In the world of behavioural economics, heuristics are viewed as a limitation when it comes to people behaving rationally in order to make decisions. Some examples of heuristics that people use in their every day life include availability heuristic (using information that is available to them as a basis for decision making), anchoring (exaggerated reliance on one piece of information to make a decision), confirmation bias (the tendency to favour information that confirms existing beliefs) and the hot hand fallacy (the mistaken belief that a streak of good luck will continue).
Heuristics remain an important tool in decision making, however it is important to remember they can lead to poor decisions if it is not supplemented with more data-driven analysis. Heuristics should be used with caution, as a tool and not be relied upon solely as a means of making decisions.