Humans have an almost innate tendency to identify recent trends and subconsciously project them into the future. Whether playing sports, investing in the markets, or picking someone up at a bar, we oftentimes cannot help but feel we have a ‘hot hand’, or, conversely, believe that we have lost our touch and that the world is against us. The key risk here is momentum bias: becoming overconfident or selling ourselves short based on recent trends.
Two forms of said bias exist. The first is positive momentum bias. Usually, in life, some things work out, and some don’t. But, on occasion, everything goes our way and we experience a string of great luck. Our timing feels impeccable. However, when we become overconfident due to a series of positive events driven by coincidences outside our control, we run the risk of making the wrong decisions. And if we let success go to our heads, we will be all the more deflated when the bubble bursts and we fall from grace. Worse, as we have seen countless times at the end of a bull market, we will lose our shirts.
The second, and even more insidious, is negative momentum bias: letting a string of bad luck affect our future expectations or personal confidence. On occasion, we encounter misfortune and events do not go as planned. Black swans occur in the markets almost regularly. Not all relationships work out. We get rejected. And, as with positive events, we have a tendency to expect the recent trend to continue. At times, we internalize the string of negative events and feel that the world is conspiring against us. The risk of negative momentum bias is that we sell ourselves short, or we get stuck.
Both forms of momentum bias lead us to make poor decisions. Our confidence level frequently gets distorted – either positively or negatively – based on events that should not influence our decisions because they are outside of our control. Certainly we should celebrate our successes and earnestly look to learn from life’s disappointments. Yet, at the same time, we must always be aware of how momentum bias can color our attitudes and our decisions. Transcend it by staying humble when you triumph and resilient when you face setbacks.
This article is based on the research and writing of Michael Schwalbe, a seasoned investment analyst and workplace psychology wonk. His work contributes to the knowledgebase of the Behance team, which runs the Behance Creative Network, the Action Method project management application, the Creative Jobs List.