Behavioral finance FAQ / Glossary (Heuristic)
This is a separate page of the G-H section of the Glossary
Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
Availability Heuristic, availability bias
01/2i,3i - 04/4i + see heuristic
(below), also : rationalization,
cognitive trap, tunnel vision,
glamour stock, mindshare,
Heuristic (bias / shortcut / limited h.)
00/6i,8i,10i - 01/6i - 02/8i,10i
- 03/9i - 05/1i,9i - 06/1i - 07/12i
- 08/5i +see availability heuristics,
anchoring, schema, framing,
automaticity bias...) + bfdef2
Still using Aunt Rose's cooking recipes?
Heuristics are mental shortcuts / simplification we use routinely, more or
* to analyze situations,
* to predict their outcomes
* and take decisions.
Said more academically, they are preset models / schemas used as easy
and quick tools to bring solutions.
In money management, an activity in which there are times
when it is urgent to react, heuristics, either well adapted or dangerously
biased, play an important part.
Useful or not?
Deciding lazily, by staying in a rut?
An heuristic, as an oversimplification and recurrent recipe can
be useful in decision making (see that phrase)...
...but only when dealing with recurrent
(*) albeit even in that case it can freeze research for better
Such a practice / rule of thumb
can easily fall into a damaging cognitive bias
in relation with:
/ habit (see those words)...
...if applied blindly even in
situations in which it
is irrelevant, such as =
Rare events (see that phrase),
Cases when past solutions,
knowledge get obsolete and
New issues or undetected
evolutions that make usual
heuristics / paradigms obsolete,
Hidden details that change how
to categorize the issue / event,
thus how to deal with it.
...by using =
Limited information or
heuristic), see below,
Or routine interpretation
heuristic), see below also.
It tends to consider as general
explanations / rules =
Too salient but partial information,
Or pure and unverified first
perception / interpretation / fancy.
Or too primitive rules and criteria.
Then it overlooks factors and
data that are crucial to
understand new situations.
A neglect that distorts individual
and collective decisions.
Neglect or hostility, out of laziness or
because it is seen as heretical.
to use other methods (see
resistance to change)
to do research and questioning
(see cognitive dissonance
Is it sometimes related to too many
or too few information?
Drowned in info?
Or thirsty for it?
An heuristic might compensate, as a first approach, too scarce
information or, why not admit it, insufficient research for information).
Of course, it might help to make some initial opinion and use
temporary precautionary rule of actions.
In that case it will be compared later to the next events or to more
extensive information (see Bayesian probabilities, adjustment...).
An opposite peril lies in the "information bias" (see that phrase), to try
to accumulate too much information up to the last drop.
To gather all data, whatever their relevance and reliability, drowns us and
does not allow us to find the leading thread to understand the issue.
Also, as human beings, we must admit that it is impossible, or at least
that it consumes too much time, effort and means, to gather and
integrate all facts and phenomena (see "cognitive overload" and
"attention biases"), so we need some simple, even automatic practice
to face many situations.
Can "big data" save us (see numeracy)? Or make the issue worse?
More about the consequences, in general
and also when markets are involved
Easy, speedy but dirty?
Heuristics as practical
and useful in many
Bring a gain of time and efforts, instead
of having to "reinvent the wheel all the time,
Allow to act fast when needed,
Give a path to look for further exploration,
like picking a fiber on the crime scene (but
with the risk that the mind get anchored on
that first interpretaion).
Fit the "Occam's razor" principle, which
states that, when in doubt, better use the
Heuristics can bring
cognitive biases in
They on their turn
cause activity and
price distortions in
For ex., investors often reduce
complex judgments by:
At the cognitive level, using simple rules
thumbs (heuristics) to take decisions.
They might be affected by narrow
assumption, limited data or flimsy
It can occur even when they think they
apply financial analysis, whether
fundamental, technical, quantitative or
On the emotional level, deciding under
greed, fear, liking, dislike
Or even, at the operational level, acting
on pure autopilot / habits (see those words).
Altogether, if we don't wonder how
relevant are our conclusions, a superficial
and lazy thinking.
=> When those biases become collective;
they bring sizeable anomalies in
financial prices, return and volatility.
Some typical heuristics
Dubious recipe book
Description: relying on...
Type of heuristic
(see below + related articles)
...Immediate perception / impression /
heuristic / bias
...General belief / stereotype / repetitive
pattern / category / relation ?
(existing or illusory, relevant or not
to the situation)
heuristic / bias
Halo , reductionism,
...Feelings seen as "instinct" or "intuition"?
...Often linked to love / hate, like / dislike
...Obsolete experience or solution,
...Or other simplified reference,
description, or relation?
Not to forget Collective heuristics
Take them with a lot
1) Availability heuristics, availability bias
Superintendent, I saw the cook with a knife in the kitchen,
why bother to look for other possible culprits?
The availability heuristics is a cognitive bias / superficial
thinking /oversimplification that narrows the
reasoning and decision-making on :
How quickly and easily people recall or find a first
information,even if it refers to an anecdotal or event or to a
superficial / salient aspect of the situation, which acts as the
main reference / anchor (priming effect).
Or how instantly they imagine the cause (the most likely
explanation) or evolution (prediction) for a situation.
Or how often people see an event, which makes them
think routinely that other events are just a repetition of it.
(here, we are close to a representativeness heuristic:
see that phrase below)
That biased mental process that "does not dig under the surface"
The most apparent, quasi magnetic traits / immediate
perception of a situation
The explanations, interpretations or consequences that come
the most easily to mind. For example relying on immediately
perceived probabilities without checking the real odds.
The most immediately available, or easy to imagine, information.
For example, glamour stocks keep on rising as information about
them become more and more widely accessible. Their fame rises
in parallel (see mind share), which attracts more and more buyers.
Sometimes copycat analogies with past situations
without analyzing if the similarities are real.
There is a neglect to enrich one's information on new evolutions,
and one's thinking in anticipating possible changes.
The tunnel vision allegory (see that phrase) illustrates that bias.
Also analogies inspired by what happens in unrelated other
areas (see halo effect).
If this similarity game is not occasional, but becomes an ingrained
mental model / pattern, it reaches the state of representativeness
heuristic (see below).
2) Representativeness heuristic, representativeness bias
Come on, supervisor, It seems to fit the chart,
so why bother to look further whether it will work?
Representativeness is "to see patterns" in a more
formal way than in availability heuristic, as the analogies
between situations are assigned here to general preset
This type of heuristic bias / oversimplification is a form of mind
representation (see that word).
Here, some events are quickly, instinctively, without digging further,
assigned to concepts, images, rules or patterns that
seem to have strong similarities.
Those general categories (stereotypes) are either individual
or common to a whole group or a population).
This can lead for example to perceive a series of
coincidences as a pattern, or to see apparently similar
cases and events as obeying the same general process,
concept or rule.
See for example "cluster illusion".
In it extreme form, when coincidences or clusters are
taken as signs from the sky,representativeness heuristic
Thus, that heuristic, that might be useful to find a first explanation
path before looking further, can become a cognitive bias
when it narrows the reasoning and decision-making on
how quickly and easily:
A belief that is usually widespread (*), and that deciders did not
make any effort to check, became a common decision criterion.
(*) For example among investors who did not do their homework
before buying or selling.
The decider becomes easily victim of a stereotype,
often drawn from past cases.
(like subscribing blindly to any IPOs because the last ones
were profitable for investors, not realizing that IPO
launchers will take advantage of that craze with higher
The fastest, most clear cut and less complicated criteria and
rule of choices (routines) are taken as useful tools instead of
trying to assess the real situation by finding the real position
of the cursor / thermometer.
Financial examples: As Martin Sewell says,
Technical Analysis is representativeness.
Here are examples:
Finding a pattern (for example a price trend) in a too
short / too recent series of data which in fact are random
There is a temptation to extrapolate it into the future.
Or expecting a reversion to the mean even in series of
events too short for that "law" to apply (see kurtosis, fat tails,
small numbers, gambler's fallacy).
3) Affect heuristic:
See that phrase.
4) Related phenomena:
See anchoring (single past reference),
See framing (reductive description / presentation)
See selection bias (focusing only on information that fit our
00/5d, 6i,10i,12i - 01/2i -
02/9i - 03/6i,11i - 04/7i -
05/1i,5i + see heuristic
(above), also image, perception,
cognitive, attention, neuro-
linguistic, framing, cluster
illusion, technical analysis
(*) To find those messages: reach that BF group and, once there,
1) click "messages", 2) enter your query in "search archives".
Members of the Behavioral Finance Group,
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