Benjamin Graham once said that “an investor’s chief problem and even his worst enemy- is likely to be himself.”
When it comes to investing, humans go through a ‘roller-coaster of emotions’ as shown below.
The Roller Coaster cycle of Investing (Courtsey : Credit Suisse)
This has led to the emergence of behavioural finance, a new field that aims to shed light on investors’ behaviour in financial markets.
Anchoring Bias
For example, if you had a favourable return on a stock when you first invested in it, your perception on the future returns of stock is positive even when there may be clear signs indicating that the stock might take a dive.
Herding
Also known as the mob mentality, is a tactic that was passed on from our ancestors and believes that there is strength in numbers.
Ironically, this herding mentality among investors is the major reason for ‘bubbles’ in the financial markets.
However, people are quick to dump stock when a company receives bad press or go into a buying frenzy when the stock does well.
As an investor, you should perform your own analysis and research on every investment decision and avoid the temptation to follow the majority.
Loss Aversion
Loss Aversion is when people go to great lengths to avoid losses because the pain of a loss is twice as impactful as the pleasure received from an investment gain.
As emotional beings, we often make decisions to avoid a loss, this could involve investors pulling their money out of the market when there is a dip which leads to a greater cash accumulation or to avoid losses after a market correction investors decide to hold their assets in the form of cash.
Superiority Trap
Confidence is an asset when it comes to investing in the stock market, but over-confidence or narcissism can lead to an investor’s downfall.
It is important to remember that the financial market is a complex system made of many different elements and cannot be outwitted by a single person. Overconfidence is the most dangerous form of carelessness.
Confirmation Trap
Confirmation trap is when investors seek out information that validates their opinions and ignores any theories that refute it.
When investing in a particular stock that believe will result in favourable returns, an investor will filter out any information that goes against their belief.
For instance, an investor will continue to hold on to a stock that is decreasing in value simply because someone else is doing the same. The investors help validate each other’s reasons for holding on to the investment, -this, however, will not work in the long-term as both investors may end up in a loss.
(Disclaimer : This blog is for information purposes only)
