A cognitive bias is a systematic error in thinking that occurs when people are processing and interpreting information in the world around them that affects the decisions and judgments that they make. This can lead to disastrous outcomes when it comes to investing.
The human brain is powerful but not infallible. Cognitive biases are often a result of your brain’s attempt to simplify information processing so it can move onto the next task. Biases often work as rules of thumb that help you make sense of the world and reach decisions with relative speed. We must however be careful to not let our brains to shortcut us to the wrong conclusion.
Markets go up and down. They always have and they always will. However, crashes and bubbles wouldn’t happen if people always made rational decisions and markets were efficient.
These events cannot be explained by modern economics alone, something else must be at work for events to occur. This is why a new theory was needed and thus the concept of investor psychology and Behavioural Finance was born.
There are many ways to describe what Behavioural Finance is all about, the crossbreed of psychology and economics, marrying the field of investments with biology and psychology or simply putting a human face on investing. No matter what label we attach to it, Behavioural Finance is the bridge between the “ideal” world of modern economics and finance or “neoclassical economics” and the real world, where we find ourselves working and investing in today.
Modern economic theory is very powerful, making specific predictions from a small number of technical assumptions but it can be mystified and come undone by the ordinary behaviour of ordinary people because we are human and human nature is unfortunately a failed investor.
This section will truly open your eyes and highlight the areas where your brain has tricked you into doing the wrong thing at the wrong time for the wrong reasons. Becoming aware of these common mistakes and irrational behaviour will set you well on your way to behaving yourself to wealth so absorb this information like a sponge because learning to understand your behaviour around investing could save you tens of thousands of pounds during your lifetime.
