How Behavioural Biases influence investor behaviour
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Have you ever felt the urgency to book profits on your investments but not so much to cut losses on the downside? Similarly, we have all made investments looking at the performance of a fund or the stock over last 1 year or 3 years ignoring other aspects such as the risk parameters, portfolio churn or the asset allocation.
The failure to think clearly, or a ‘cognitive error’ is a systematic deviation from logic. These errors in judgement are not occasional blurs, but rather routine mistakes, repeating patterns through generations and through centuries. Our mind has been tuned to think in a certain pattern overlooking the existence of other possibilities. The stock markets often capture these inefficiencies although they are suppose to be efficient with the advent of Algorithmic trading dominating majority of the volumes. The information is absorbed instantly and this has led to markets rising and falling synchronously across the globe.
So how do we avoid these cognitive errors of judgement? It is not easy to fool your mind which knows you better than yourself but it is not entirely impossible. It will require practice and looking at your decisions more objectively rather than emotionally. I have tried to list down some ways to avoid these biases in investing. This list is not exhaustive but is definitely a start:
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- Trade less and Invest more – You will have to trade less and invest more because while trading you are up against the super computers and Algos who have better access to data and have analysed the information much more extensively. The odds are hugely stacked against you soby increasing your time horizon you would likely build wealth over time. Resist the urge to believe that your intuition and information is better than others in the market.
- Avoid the feeling of regret – It happens with every one. You were confident that stock is fairly priced and its price is bound to skyrocket. It starts slipping down but you are all the more convinced that it is a great price to buy and hence you invest more. It comes down further but you still make yourself believe that you are in it for the long term and it is a value buy. You are trying to avoid the feeling of regret because as humans our mind is tuned to avoid that feeling. Best way is to avoid this error is to set rules for investments and you will stick by those rules. Make sure you do not let your emotions come in to play here.
- Do not fall for predictions – Every day experts bombard us with predictions, but how reliable are they? A study conducted over a period of 10 years, 28361 predictions from 284 self-appointed professionals revealed that the experts faired only marginally better than a random forecast generator. So how can we verify if the prediction is worth considering? Firstly, consider the incentive behind the expert making those predictions. Is he an employee who is answerable for the predictions he makes? Secondly, consider the track record of his predictions. This should give you a fare idea on how one has fared over a period of time.
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Conclusion
Avoiding behavioural biases are not easy but they can be reduced by practice of objective thinking over a period of time. Be on the lookout for convenient details and happy endings. It is important to dwell more and look for details not easily available. Most importantly, keep the emotions out of investments as the legendary investor Warren Buffet said “ If you cannot control your emotions, you cannot control your money”
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