Tuesday, January 19, 2010

Insights From Behavioral Finance

Insights From Behavioral Finance

Most common biases which have been unearthed by Behavioral Finance Experts are as follows-

1. Over Confidence
- We attribute our skills for our success but blame others for our failures.

- Over trading when we are successful and extreme caution when we lose money.
- Over concentrate into a single stock or few stocks

- Overconfident investor is only a trade away from a very humbling wake-up call.

- Good amount of skepticism is needed for every position.

2. Selling Winners and Keeping Losers (Prospect Theory)
- A loss is two times more painful than a gain
- So we don't like taking loses even when we have made mistakes about prospects of a company.
- On the other end taking profits makes us feel better so we sell winners prematurely.

3. Herding
- One of the most important words of Sir John Templeton, "This time it is different is one of the most expensive words in the English Language"
- when bubbles form or when stock becomes a darling people just herd into it.
- Obviously it is dangerous to prick a bubble, any one who shorted Nasdaq stocks in 1999- 2000 was out of the market.

4. Hindsight Bias
- People think they could have predicted an event after the fact it has occurred.

5. Survivorship Bias
People only look at the survivors to theorize from the result they never look the prople who have been dead and are not included in the statistic.