Cognitive biases are errors in human thinking. They can impact decision-making in various areas of life, including the stock market. Here are a few cognitive biases that can influence stock market behaviour:
1. Confirmation Bias:
This bias occurs when someone seeks out information that confirms their existing beliefs or opinions and ignores or dismisses information that challenges those beliefs. In the stock market, confirmation bias can lead investors to selectively focus on information that supports their investment decisions, leading to over-confidence and potential investment mistakes. Read more about Confirmation Bias here.
2. Herding Behaviour:
This bias involves individuals following the crowd and making investment decisions based on the actions of others rather than conducting their own independent analysis. In the stock market, herding behaviour can lead to market bubbles or crashes, as investors tend to follow the trend without fully evaluating the underlying fundamentals of a stock or the overall market conditions. Read more about Herding Behaviour here.
3. Anchoring Bias:
This bias occurs when an individual relies too heavily on the first piece of information they encounter when making decisions, even if that information is not necessarily relevant or accurate. In the stock market, anchoring bias can lead investors to fixate on a particular stock price or valuation, even if new information becomes available that challenges that anchor. One of the most common warnings we hear in the stock market is there to remind us of this bias: past performance is no guarantee of future financial performance.
4. Overconfidence Bias:
This bias involves individuals overestimating their own abilities or the accuracy of their judgments. In the stock market, overconfidence bias can lead investors to take on excessive risk or make overly optimistic predictions about the performance of their investments, which can result in poor investment decisions and financial losses. Read more about Overconfidence here.
5. Loss Aversion:
This bias refers to the tendency of individuals to feel the pain of losses more strongly than the pleasure of gains. In the stock market, loss aversion can lead investors to hold on to losing investments for longer than they should, in the hope that the stock price will rebound, rather than cutting their losses and moving on to better opportunities. Read more about Loss Aversion here.
Managing Cognitive Biases is Critical:
It’s important to recognise that cognitive biases are inherent to human thinking. They can impact decision-making in the stock market. Being aware of these biases and taking steps to mitigate their influence can help investors make more rational and informed investment decisions. Developing risk management skills in our ‘Invest for Success’ Program, will help reduce the impact of cognitive biases in stock market investing.
Stock Market Investor Education:
‘Invest for Success’ – is a 4 week program starting with a 2 day in-person workshop + 4 x 1 hour online sessions over 4 weeks. Call us now for more information +61.2.9488.9900.