Question

Give a few examples of psychological factors or behavioral biases that could affect investment behavior. How do they affect investment behavior?

Answer 1

Psychological Factors that affect investment behaviour

1. Overconfidence

When somebody overestimates their ability, skills or judgement it means that they are overrconfident. Investors can get overconfident sometimes when they start believing that they can control the factors affecting markets or when they believe they can have an effect on the outcomes of their investments.They think they can choose stocks more effectively than others and they only know the best time to enter and exit the market.They think they can make superior decisions as compared to others with relation to their investement. Confidence is a good thing but over confidence can lead to huge losses. Confidence helps an investor to make good profits while overconfidence can lead to bad outcomes.

2. Optimism

Optimism means having a positive outlook no matter what the facts are. It means ignoring the facts and believing everything will turn out alright. Optimism can lead to losses if it is misplaced. Investor might be hoping for the market to go up and might ignore the signs that the market is going down in future.This may lead to frustrtion. Having Optimism is good in investors but misplaced optimism is harmful.

3. Fear of Loss

Losing is something that nobody likes. A lot of investors are afrid of losses. This may lead to irrational behaviour from investor which might affect not only the profits the investor makes but also the market.

4. Herd Behaviour

Herd Behaviour is bindly following somebody without undertanding the reasons behind it. A lot of investors discuss their investments with fmily, friends, relatives and colleagues. A lot of times, Investor will blindly invest in a stock because his frienda, family , colleagues or relatives have done so without understanding and studying the stock and making a informed decision about the stock. Herd Behaviour can affect the market as a large number of investors may buy or sell the stock and lead the market into a direction.

5. Consultancy Effect

Recommendations from analyst's can affect the investor behaviour. A lot of investors are out for guidance and are of the opinion that analysts' recommendations will always be good.

6. Cognitive Bias

Cognitive bias is when a person processes an obtained information based on his or her personal experience, likes and dislikes. An investor might not invest in a profitable stock due to some bad experience with the stock in past. Alternatively, an investor might invest in stock just because he likes a stock.