behavioral finance Flashcards
behavioural finance
-cognitive error: error resulting from faulty info processing or memory. often arise from the brains attempt to simplify info processing
-emotional biases: errors resulting from the priority of human emotions over rational decision making
relfexive system
-emotional
-automatic
-info first processed here
-process huge volumes of info very quickly
-below level of consciousness
-creates psychological traps
advantages:
-for badly structured porblems
-incomplete, changing and ambiguous info
-high level of stress
-a corret theoretical framework is key to overcome our own nature
reflective system
-provesses info in logical and analytical manner
-active effort
-takes longer
-for complex problems
-can help us to avoid falling into mental traps
-detect which are the bahvioral blases or mental traps and why do they originate
-develop a rigorous investment process to minimze the probability of making errors
-follow the process rigorously and with discipline even when during short periods of time it doesnt seem to work and everybody seems smarter than yourself
cognitive errors
-conservatism bias
-confirmation bias
-illusion of control bias
-anchoring bias
emotional biases
-loss aversion bias
-herd thinking bias (regret-aversion bias)
-overconfidence bias
-self control
conservatism bias
-cognitive error
-investors rationally form an initial view but the nfail to change that view as new info becomes available
-investors are unwilling to update a view and therefor hold an investment too long
-investors hold an investment too long to avoid mental effort or stress of updating view when info to complex to understand
-constantly review new info that affects our investments and incorporate info in our investment analysis
confirmation bias
-cognitive error
-investors look for new info to support existing view, Info that contradicts view is more likely to be ignored
-hold investments too long
-set up decision process incorrectly
-under diversify
-investors must constantly seek out contrary views and info –> desotrying the thesis
illusion of control bias
-cognitive error
-market participants think they can control or affect outcomes when they cannot
-trade more than is appropreiate as they believe they can control the outcome
-excess info that gives the appearnce of having everything under control
-fail to diversify
-investors should be humble only can control price, keep good records to document the thinking behind ideas and reviewing to see if there are patterns
anchoring bias
-cognitive error
-investors stick to their initial view and changes are done around that initial view, rely to heavily on first piece of info
–struggle to adjust to new info
-struggle to sell stock as they anchored to the price which they bought and wont sell until price recovers
-ask questions like am i becomign too dependant on a previous price, would i reccomend this investment, forecasts should be updated
loss aversion bias
-emotional bias
-arises from feeling more pain from loss than pleasure from gain
-hold onto losers too long sell winners to quickly, to not trigger negative emotions of losses and in fear of decreasing profit in future
-trading too mich by selling for small gains
-maintain a discplined well thought out investment process based on future prospects of an investment
herd thinking bias
-emotional bias
-afraid of psychological pain that arises from acting against the group
-investors do what rest of market does
-having correct framework helps us take informed decisions independently
-correlated to overconfidence bias as we listen more to people with strong confidence -> relaet on experts without critical thinking
overconfidence bias
-emotional bias
-overestiamte their own intuitive ability or reasoning
-investors will fall in temptation of trying to predict the future
-wont give necessary importance to uncertainty and will underdiversify
-keep trading records review them periodically to see if the thesis unfolded postively
self control bias
-emotional bias
-lacking self discipline and fail to acknowledge how they will feel when they have to take a decision in the future
-investment errors
-investors feel the need to act when things are changing instead of doing nothing
-plan in advnace when not much is going on the market take decisions when you are calm
