Cognitive Dissonance Definition Top 4 Examples

Cognitive Dissonance Definition

The examples below help us understand how cognitive dissonance affects the financial market and how it impacts the individual.

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Top 4 Examples of Cognitive Dissonance in Everyday Life

Example #1

John is looking to buy a stock of XYZ Ltd. because he believes that XYZ Ltd. will perform well in the future. XYZ Ltd. stock is currently trading at $70, and John is considering buying a stock if it falls a few dollars to $65. However, in three days, the stock price hit $68, and John believes the stock price will come to $65 sooner. However, after three days, the stock price suddenly increased, reaching $75 because of buying demand from other investors. At this point, John will probably experience cognitive dissonance.

Now, the question arises, why will John experience cognitive dissonance? So, we will try to find out the answer to this.

Here, John will feel discomfort because of the sudden increase in the stock price of XYZ Ltd., which showed that the stock was good to buy at the cost of $68, and the market suggested this compared to the last trading price. Therefore, there are high chances that John will buy some of the stock at the cost of $75 to relieve the discomfort he feels. Of course, John may think that buying a stock at a higher price is still good because other investors are also buying at the same price, but this rationalizes buying John as irrational.

The above example shows that investors should stick with their decision and not determine the trade by emotion.

Example #2

One of the investors thinks that the current market is too high and may fall soon. Since the market is too high, the investor is worried about it and planning to sell some equity holdings. The investment manager asked investors, “Why does he think the market would fall shortly?” He says that the global economy is slowing down, as published in several newspapers, and corrections will happen in the marketCorrections Will Happen In The MarketMarket Correction is usually referred to as a fall of 10% or more from its latest high. It happens due to various reasons such as declining macro-economic factors, intense pessimism across the economy, securities specific factors, over-inflation in the markets, and so on.read more. Then, the investment managerInvestment ManagerAn investment manager manages the investments of others using several strategies to generate a higher return for them and grow their assets. They are sometimes also referred to as portfolio managers, asset managers, or wealth managers. They may also be considered financial advisors in some cases, but they are typically less involved in the sales aspect.read more advises investors that do not get influenced by numerous news articles.

Even after the investment manager advised, investors sold out his 50% equity, and the next day, the market tumbled by 5%. As the market dropped by 5%, the investor felt good and thought he had made the right decision. Still, after a week, news came out that the global economy was improving, and the market started showing a rally. So, now, investment managers suggest investors add back sold equity into the portfolio to get long-term investment plans on track.

So, the above example shows that investors influenced by particular news articles made sold-out decisions without checking facts and figures and made a mistake. It shows that cognitive dissonance can cause the investor to fail to recognize the information, which helps him make a good investment decision.

Example #3

Keith is still hoping that the company’s position will improve, and he will get at least a stock price of $125.

So, the above example explains that the investor who bought the stock despite it was falling heavily and sitting in huge losses. So, an investor looks for positive news and information about the company to support his buying decision and hold on to the investment to sell it at a profit in the future.

Example #4

During the stock market rally or boom in 2005-2007, the investors in India were investing in companies of capital goodsCapital GoodsCapital goods are man-made assets used in the manufacturing process of a product. They are used to produce the final goods that people consume daily. They are one of the four factors of production- the other three being natural resources, labor, and entrepreneurship.read more, infra, and the power sector. Fortunately, at that time, those stocks were rallying sky high. The investor was confident that he had enough skills and expertise to pick stocks because whatever he picked went up almost daily. He also entered into a few hot IPOsIPOsAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more. Then, when the global economy was facing recession in 2008, the investor portfolio suffered badly, and he sold off his entire portfolio at a loss.

The above example shows that overconfident investors and traders believe that they are better than everyone else in choosing the best stocks and funds and an even better time to enter and exit the position because they think they are better and wiser than others in choosing an investment.

Conclusion

So, the above examples explain how cognitive dissonance influences investment decisions in financial marketsFinancial MarketsThe term “financial market” refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more. Cognitive dissonance is a varied case-to-case basis. It applies to many situations. Most people are motivated to justify their actions, beliefs, and feelings in cognitive dissonance. Therefore, they use self-perception when dealing with any condition, as seen in the above examples. The best way to avoid cognitive dissonance is to be objective and analytical while making investment decisions rather than emotional.