Investor psychology: Know your biases
Investor biases fall into three categories:
1. Not thinking clearly:
- Overconfidence --
precipitated by the illusion of knowledge and the illusion of
control, it causes investors to trade too much and take too much
- Attachment -- leads
investors to focus on a security's good traits and ignore bad
- Endowment -- when
securities are given to an investor, the investor tends to keep
- Status quo -- leads
2. Emotions rule:
- Seeking pride -- causes
investors to sell winners too soon.
- Playing with the house's
money -- prompted by a winning streak that causes investors
to take undue risks.
- Avoiding regret --
causes investors to hold losers too long.
- Snake-bit -- prompted
by a bad investment that causes investor to avoid risk entirely.
- Getting even -- prompted
by a loss, clouds judgment and leads to greater risk-taking.
3. The way the brain works:
- Cognitive dissonance
-- filters information, changing recollections of bad experiences
and impairing an investor's ability to properly evaluate investment
-- the brain's way of reducing complexity by making shortcuts
and judging information based on stereotypes or previous experiences,
leading investors to put too much faith in stocks that are familiar
or represent desirable qualities.
Madness: How Psychology Affects Your Investing ... And What to Do
About It by John S. Nofsinger.
-- Updated: May 11, 2004