You decide the pound is going to strengthen, and suddenly the news seems to be full of coverage about a falling US dollar and a Bank of England rate hike in the coming months.
In short, your own mind acts like a compulsive ‘yes-man’ who echoes whatever you want to believe. Psychologists call this mental phenomenon ‘confirmation bias’.
A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs.
Why is a mind-made-up so hard to change?
“We’re all mentally lazy,” says psychologist Scott Lilienfeld. “It’s simply easier to focus our attention on data that supports our hypothesis, rather than to seek out evidence that might disprove it.”
It is also is easier for people to rationalise than to be rational. “We’re very good at cooking up post-hoc explanations of why our predictions didn’t work,” Prof. Lilienfeld says. “We reinterpret our failures as near-misses: ‘This stock would have gone up if only X had happened,’ or ’99 times out of 100 I would have been right if not for this freak event.’”
The more you learn, the more certain you become that you are right. While gathering more data makes people more confident, it doesn’t make their prediction more accurate. Each new fact makes you more inclined to find another fact that resembles it, reducing the diversity and value of your information.
So how can you counteract confirmation bias when it comes to implementing your foreign exchange strategy?
Imagine the exchange rate moving significantly against you – say 15-20% overnight. What would that mean for your business? Would you be able to absorb such a movement in your profit margins? Could you re-negotiate price reductions with your suppliers? Would your customers tolerate a price increase?
Next come up with the most compelling reasons you can for such a movement. A Brexit style event or surprise financial market crash like in 2007-8. This exercise can help you realise that your beliefs might not be as solid as you thought.
Ultimately, you have to create a foreign exchange strategy that protects your business from the worst-case scenario not one predicated on a belief that the market will move in your favour. This requires removing the emotion from your hedging decisions and implementing a strategy in a more structured and formal manner.