Psychological Biases Affecting Investment Decisions

I never thought of one’s personal psychology would have such a deep impact on making investment decisions. I believed that people with a high level of knowledge and sufficient experience would always make rational decisions and predict future tendency appropriately. Almost everything changed after taking the Behavioural Finance lecture. For example, traditional finance assumptions tell us that people are risk averse. People’s behaviors should be consistent with their level of risk tolerance. However, in the real word, these assumptions are violated due to psychological biases. I was delighted to know how emotions and cognitive biases affect financial decisions, corporations, and the financial markets.

I am always thinking myself as quite a risk averse person. But he results of the tutorial tests show that I am a risk-taking person with a high-risk tolerance which is contrary to my expectation. As the lecture carrying on, I know more about different kind of psychological biases and …show more content…
In reality, the situation might be just the opposite. There is a psychological bias called the misattribution bias. That is, people often misattribute the mood (or affect) they are into the financial decision at hand. For example, we feel good when today is a sunny day. Furthermore, we will be more optimistic about future prospects and more likely to buy stock than sell stock. Researchers have found evidence that sunny days outperformed miserable weather days with higher returns. Since our investment decision inevitably influenced by emotion, why not take advantage of this for predicting stock price trend. Also, we need to control our emotions carefully. Optimistic investors tend to be less critical while pessimistic investors tend to be more analytical. Do not show excessive optimism or excessive pessimism because both of the two emotions will cause decision-making