Investor Psychology: Cognitive Biases and How to Defend Yourself
Investment decisions are not always rational: behavioural finance shows that we are subject to numerous cognitive biases that can harm our results. Understanding them is the first step to avoiding them.
1. Most Common Biases
- Confirmation bias: we look for information that confirms our opinions and ignore data to the contrary.
- Anchoring: we fixate on a purchase price or a previous high/low and struggle to sell at a loss or buy on new highs.
- Recency bias: we attach too much importance to recent events, neglecting the long-term history.
- Illusion of control: we believe we have more control over the market than we actually do, leading to overtrading. Academic studies show that excessive turnover reduces net returns for retail investors.
2. How to Defend Yourself
- Establish ex-ante rules: target asset allocation, rebalancing thresholds, rational stop-losses.
- Adopt a PAC to invest gradually and reduce the emotional impact.
- Keep an investment diary to reflect on decisions and associated feelings.
- Rely on an independent adviser to anchor choices to data and documented strategies.
Remember: recognizing biases is the basis for avoiding them. For a complete behavioral education program, write to me