Behavioural Finance!

Behavioral Finance has been one of the most famous topics for the last couple of years as it offers a whole new way in explaining the “market anomalies”. Basically what it does is to study how and why people will react in certain ways in the financial markets.

Heaps of researches have been conducted on behavioral finance over the last decades. Human’s emotions such as regrets, greed, fear, hope and etc has been the main drivers behind the numerous Bull Run and crashes. Buy low sell high, it’s always easier to be said than done, and it’s always way easier to say it in hindsight, or when you’re sideline.

But when you take up some position in the market, pretty much, you will be “disillusionised” by the market movement. When the price is creeping up, you’re hoping for more, or you might think, “Dude, I have enough, let’s sell it!” When the price is coming down, you might be thinking, “tomorrow it will go up, it’s just a paper loss, it’s not an actual loss! We’ll be fine…” and keep on praying. But according to the rule of thumb, shouldn’t you be selling when the price goes up, and keep buying when the price tumbles?

It’s Greed and Fear. You want more, but you’re afraid of losing. Losing is painful and research shows that people are very reluctant in realizing loss. But interestingly in this rising market, people are very reluctant in realizing gain as well, because the feeling of Regret, i.e. the price continues to soar after you sold is almost equally as painful as realizing loss. Well, it’s your call mate!

In an over-valued market like this (depending on how you value it), people always neglect the fundamentals. Well, in a perfect world, fundamentals should be the determinants that drive prices, but, in reality, it seems like anticipations play a bigger role!

The studies on anticipations, regrets, fear, greed, hope and etc led to the birth of behavioral finance. It’s just like doing a psychological test, the more you could understand how you think, then you should be able to understand what others think better, in turn, you should be able to read the market better!

Let’s do a simple test. This is a famous question by Kahneman & Tversky’s research

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Choose 1 from (a) (b) and 1 from (c) (d) the following

(a) A sure chance of getting $2,400, or
(b) A 25% chance of getting $10,000 and a 75% chance of getting nothing.

(c) A sure chance of losing $7,500, or
(d) A 25% chance of losing nothing and a 75% chance of losing $10,000
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What do you say?

Email me your answers to financialgeeks@gmail.com to find out more!