Beliefs and prejudices are elements of emotion that result in the orientation of our attitude in our daily life. If beliefs are at the heart of our will, their influence is visible in our choices. Considering therefore that convictions guide most of our choices, it is not uncommon to observe perverse effects of the latter. Thus, emotion usually leads to biased actions based on feelings and not on facts. In this article, we take a look at how emotion can affect an investor’s decisions.
The investor faced with overconfidence
Confidence is a laudable and essential attitude in many aspects of professional and even personal life. However, when it goes too far, financial decision-making can have serious consequences. Discover online trading, a field of activity where overconfidence is very present. According to several studies, professionals in liberal activities, online traders and business managers have too much of a vision of their contribution to achieving positive results.
Excessive confidence perverts the capabilities of the investor
When an investor has too much self-confidence, he thinks he has a lot of control over events. However, this is not always the case. It is easier for an overconfident investor to ignore the complex nature of investment forecasts. He will tend to overestimate his ability to assess and determine the best investment opportunities.
The majority of experts rely on their expertise to overestimate their own abilities. They tend to attribute their successes to their unique analytical skills. This is what predisposes them to the temptation of fraud. The sensitivity of rich investors to investment fraud is caused in the vast majority of cases by overconfidence according to the economist Steven pressman.
A very clear example of overconfidence can be found in active trading. Indeed, overconfidence is often identified as the main weapon of online brokers, which would allow them to seize the best opportunities. According to several studies, active traders (those who trade excessively) would perform below average in the market. In contrast, traditional brokers (those who communicate with a phone) perform the best in the trading market.
Self-attribution biases the evaluation of performance factors
Along with overconfidence, self-attribution is one of the behaviors that plague investors. We speak of self-attribution when the investor links all the good results to his personal actions. Likewise, it returns bad results to external causes. The truth is, self-attribution can very easily lead to overconfidence. The investor plagued by this behavior cannot avoid the underperformance of its investments. The best way to raise the bar would be to measure successes and failures alike and put in place accountability mechanisms.
A taste for risk conditions investments
Risk and return are generally related according to the laws of market theory of financial efficiency. This relationship is explained by the fact that a high investment is usually associated with a high risk. And the return on that investment is also high. For investors, it is then a question of finding the highest return which would be in relation to the level of risk that they will be able to bear. However, this theory is swept into the reality of behavioral finance.
The investor facing loss aversion
Contrary to the market theory of financial efficiency, behavioral finance believes that investors are influenced more by losses than by risks and returns. This has been demonstrated by Dan Kahneman and Amos Taversky, the pioneers of behavioral finance. According to their studies, an investor would choose to avoid losing a certain amount of money instead of seeking to earn an equivalent amount.
The losses would make investors think twice as much as the return or potential gains. This explains why people accept a smaller probability of loss more quickly than a large investment giving substantial results.
So if you offered people the choice between receiving $ 900 and having the 90% chance of winning $ 1000 – and therefore 10% chance of losing everything – the majority would choose to receive the $ 900. The instinct not to lose would push them to make this choice rather than taking the risk of winning more.
The contribution of anchoring in investor decisions
Beliefs have a great deal of responsibility in the behavior of investors when faced with opportunities. When they believe in something, they hold on to that belief which will serve as a point of reference for future appreciations. Generally, the first impression obtained on a subject influences the appreciation of the other information which arrives second.
Anchoring occurs in different areas of life. For example, speculation around the price of housing in real estate is often influenced by arbitrary price posters. Likewise, prosecution indemnities are assessed on the basis of the plaintiff’s request.