Markets do go up and down. However, crashes and bubbles shouldn’t happen if people 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!”
Key Concepts
The key concepts/ideas in Behavioural Finance that go some way to explaining how and why we make poor decisions are the use of heuristic techniques, biases, and context.
Behavioural Finance
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.
Biases & Theories
People are inclined to often invest with preconceived ideas, or behavioural biases, that can result in decisions based on emotion. This section details some of the biases and theories that an investor can be susceptible to.
Cognitive Biases
A cognitive bias is a systematic error in thinking that occurs when people are processing and interpreting information in the world around them and affects the decisions and judgments that they make.
How to Respond to Crashes & Corrections
Throughout stock market history there have always been crashes and corrections and there always will be. It is part and parcel when investing. It’s at precisely those times of extreme market turbulence that investors tend to make their biggest mistakes. Here we look at what you should do when these events happen?
Focus on What Matters
We often tend to worry about things of which we have no control over. It’s far better to concentrate and focus on the things that matter and that we can control. It is not always an easy thing to do, but you will feel far more relaxed once you are able to. Here we look at how to address this issue.
The Number One Lesson from Market History
It is often assumed that to be a successful investor you need to be an expert in economics. In fact, far more useful is a knowledge of history, particularly the history of the financial markets. As Mark Twain famously said, ‘History doesn’t repeat itself, but it often rhymes.’ Here we look at one standout lesson that history teaches us.
Why Market Forecasts are Best Ignored
The investing profession is full of people who claim to be able to predict the future. You often see them on the TV or quoted in the media. But forecasting developments in the economy and movements in the stock market is notoriously hit and miss and nigh on impossible. Here we examine just why it is.
