Trade The Journey

Trade The Journey

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Financial Psychology- Natural Inclinations

There are bias that we naturally have as human beings, that we can’t get rid of.  Natural inclinations that can spell doom for an investor which is why investing is extremely hard to do. Its also the reason, managing our finances is so damn difficult. We are naturally inclined to do the opposite of what is in our best interest in the long term.

Here are some of the bias we should be on the look for:

Confirmation Bias- Willingness to accept any information reinforcing existing views. Often ignoring information that is contrary to existing views.

Overconfidence- Better than you really are.

Self-Attribution- Disappointment is attributed to bad luck rather than lack of skill. Optimistic and wishful thinking reign supreme.

Stereotyping- You understand developments on the basis of too little information.

Perseverance- People cling to prior opinions for too long and especially when confronted with contrary evidence that would be enough to convince newcomers in the field.

This happens to come from the book on Advances of Behavior in Finance, which kind of goes against the idea of market efficiency. From what I gathered from the book,  people are highly irrational and subject to the bias listed above. This causes mispricing and volatility in a market deemed as efficient and able to adjust.

Is it possible that a companies stock price can be overstated based on the belief of the crowd for long periods of time? Can a risky investment pose as a good investment for the foreseeable future and when can you tell sentiment is changing?  Any help we receive in understanding ourselves will help us understand others.

Predicting the movement of others should be more perceptive than quantitative and nowhere is this more apparent than in the behavior of the investor you are competing against. Each bias can be a contributing factor to the mispricing of the stock and buying at the most opportune time.

Behavior financial should be added to your curriculum even if you are not a trader or an investor. Knowing your particular susceptibility to the different bias you hold will help you better navigate through personal finance and investing challenges. Thoughts, criticisms, corrections and most importantly suggestions?

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