People are not perfect or exact machines and our investment behavior reflects this complex reality. In recent years, research on behavioral finance has risen sharply to better understand how investment decisions are made and what that means for investors in particular and markets in general.
Researchers have identified a number of widespread distortions that often negatively impact the return on our investment. Then we refer to three prejudices that are of particular importance when working in the financial markets.
Prejudice is the direction in which investors seek and determine their value, in particular the information that matches our views, without sufficiently reflecting the information that leads to contradictory conclusions.
Theoretically, people should analyze all available information and then draw objective conclusions based on that information. However, the process of collecting and interpreting information is quite different in real life.
Investors who value the market in general or a particular asset tend to focus on data that supports their previously expressed beliefs, and the same applies to those who have negative expectations. This type of bias can be particularly dangerous because it does not allow a correct assessment of the potential for errors that is incompatible with risk management standards.
The use of social networks in terms of investment can be of great value, although it can compound the problem of bias bias. Some social network investors only interact with people who share their views, which amplifies the bias problem by increasing the flow of information in the same direction.
Aversion to losses
Decisions to buy or sell an asset are not made solely on the basis of rational issues, but emotions can play a key role in this context. Selling a loss often involves huge emotional costs as we suffer losses and ultimately give up hope of recovery.
Unfortunately, this often results in investors holding positions that are longer than adequate, which could further exacerbate the losses. This means that if we do not want to sell at a loss of 10% in one month, we can sell at a loss of 30% per year.
Of course, it is not a mistake to be patient when you earn the quality of the original, but the key point is that the emotional components of the decision often influence our ability to analyze and make decisions.
The problem of shifting too much revenue is not just that the losses can get bigger, that in itself is obvious. The capital that we have invested in a disappointing situation is not available for potential high-potential investments, and these opportunity costs can significantly impact long-term returns.
An old joke on the market says “a long-term investor is a short-term investor who did not know in time”. Many of the best investors in the market usually have a long-term focus, but these investors plan their investments initially during this period.
If the process is planned on a short-term horizon, then we extend the term to a market that is not developing well, we will likely be affected by emotional bias that reduces our ability to make smart investment decisions.
Excessive confidence arises when the investor increases the value of the information he or she owns and / or the ability to make decisions based on that information. A worrying aspect of this bias is that people who suffer from overconfidence recognize this bias least because it is difficult for them to accept their mistakes and shortcomings.
The investor concerned by the excessive trust normally attributes his profitable business to his own merits and abilities, while the loss of transactions is due to adversity or manipulation of the market or any other factor outside his area of responsibility.
Excessive trust also leads traders to take excessive risks, operate more frequently than appropriate, with very large positions and excessive leverage. If the results of the process are not favorable, excessive trust can have disastrous consequences, as the operator does not have the necessary perspective to recognize the situation and reduce the loss.
It is clear that all human beings are more or less exposed to this sort of bias because they are part of human nature itself. Therefore, it is important to be aware of and be aware of these issues in order to avoid over-impacting the decision-making process and the results we achieve on the market.