We’ve all seen investment decisions that defy logic, made by the most brilliant minds and investors in the world. Research shows that our financial decisions are influenced by our psychological biases. Let’s explore the most common psychological biases in the financial markets. First of all, let’s define what are psychological biases and how important they in investment.
A psychological bias is a psychological shortcut that the mind use to treat any information quickly, based on its habits. Although it is an interesting and helpful habit, it often lead to strategical errors when it comes to investment.
The most common psychological biases
Among the most common psychological biases, we can list:
- Overconfidence: Considered as the most common one, overconfidence encourages investors to believe that they know more than what they actually do. It often leads to wrong behavior regarding financial decisions, such as neglecting portfolio diversification or overtrading. Whilst an overconfident investor might think they can make very successful yet risky decisions, the market unpredictability can be a huge challenge, which may result in consequent losses.
- Confirmation bias: This bias can result in heavy consequences, as this usually happens when certain investors seek out confirmation for their existing knowledge. This type of investor is only interested in information that approves their knowledge and avoids any evidence that may contradict their perception or their basic knowledge.
- The herd mentality: It’s important to consider that every investor, like the rest, wants to make the best financial decisions. One of the most common strategies is to check the trends and copy other investors, assuming that if a wide circle of investors make the same choice, it must be correct. This bias is present mostly in cryptocurrency markets, as it is a new market that is not yet mastered and accessible to everyone.
So, what is the real impact of psychological biases on your portfolio performance?
Psychological biases impact both short-term and long-term financial decisions, resulting in changes within the investor’s overall performance. An investor who falls victim to this may make impulsive decisions, especially during complicated periods such as market volatility or when the Fear Greed Index points towards one extreme or the other. The 2008 financial crisis is an excellent example representing key moments in the market’s history where this psychological behavior led to very heavy consequences.
What do experts recommend to overcome psychological biases?
To overcome psychological biases when investing, the first and most important step is self-awareness. Taking time to study past decisions can help any investor understand their way of investing and the errors they made. Then, an investor can start relying more on data than intuition, this will significantly improve the decision-making. Investment, like any other field, is filled with experts and professionals who can help any investor towards their long-term goals. It’s better to consult an expert on the subject if any difficulties are present.
This article is for informational purposes only and should not be considered financial advice.
