A key element of Behavioural Finance is cognitive bias,
and the psychological influences that underpin it.
What is Behavioural Finance?
The world of investing often experiences irrational behaviour from both financial professionals and investors. Behavioural Finance seeks to recognise why markets are not always efficient, and uses psychology, sociology, economics and finance to explain these inefficiencies.
A key element is cognitive bias and the psychological influences that underpin it.
Download our Behavioural Finance infographic
Behavioural Finance is an area of study that combines psychology,
sociology with economics and finance.
This explains systemic biases that are exhibited by financial markets and investors. It asserts that people often behave irrationally based on emotion and cognitive biases.
Biases can lead to poor financial outcomes
A great example is the U.S stock market crash of 1929. During the late 1920’s a bull market led the American public to become increasingly optimistic that increasing stock prices would continue to rise. A vast sway of the public got caught up in the hype which eventually led to a major economic crash. A great example of Herding Bias.
This is an extreme example, but clearly demonstrates the effect and outcomes of cognitive bias. Through understanding Behavioural Finance, investors are able to understand the psychological influences on their decision making, and potentially avoid costly financial mistakes.
Here are some of the most common behavioural biases
Confirmation Bias Infographic
Confirmation bias is when individuals have an unconscious tendency to look for information that supports their pre-existing beliefs.
Recency Bias Infographic
Recency bias, (also known as availability bias), is when
people give increased weight to more recent events, often ignoring information gathered over a longer time period.
Anchoring Bias Infographic
Anchoring bias is relying heavily on an initial piece of information, the anchor. Subsequent decisions have a bias towards interpreting new information around the anchor.