Bias 1: Overconfidence
Many novice investors get lucky: The first few stocks they pick do extremely well. Unfortunately, they start believing in themselves. They think they have a magic touch; or worse, they think they are smarter than everyone else. This often leads to disaster….
Therefore, the wise investor not only knows how to recognize signs of overconfidence in himself (such as bragging about one’s short-term investment performance), he also knows how to apply the brakes when the signs become visible. In other words, he has learned at some point how to use reasoning to overrule his emotions.
Bias 2: Familiarity
The second bias, called familiarity bias, may cause some investors to be too concentrated on opportunities in their own countries. They are more familiar with and confident about local investment opportunities, so despite the fact that it’s much easier than in the past to diversify investments across geographies, they go with what they know and can easily understand.
Another example of familiarity bias is a tendency by investors to buy shares in the companies they work for. In doing so, the investor may become over-allocated to the company stock and the unsystematic risks that come from being under-diversified. Individuals that are over-allocated to company stock take the risk of having their assets and their income significantly reduced should the company go through a period of financial difficulty. To weed out familiarity bias, a good approach for the New Year would be to discuss different investing strategies than you typically use with your financial adviser and then consider employing those that are appropriate for meeting your unique financial goals
Bias 3: Anchoring
A third and final bias I want to touch on is the idea of anchoring, or becoming fixated on past information and using that information to make inappropriate investment decisions.
When investors are influenced by this bias, they may not be able to get their mind off a particular sell-price target, even if new information is available or the investing landscape has shifted significantly. They become stuck and may even ride markets to the bottom if they cannot let go of what they think the price “should” be.
One thing to remember said by one of the experienced trader
Many novice investors get lucky: The first few stocks they pick do extremely well. Unfortunately, they start believing in themselves. They think they have a magic touch; or worse, they think they are smarter than everyone else. This often leads to disaster….
Therefore, the wise investor not only knows how to recognize signs of overconfidence in himself (such as bragging about one’s short-term investment performance), he also knows how to apply the brakes when the signs become visible. In other words, he has learned at some point how to use reasoning to overrule his emotions.
Bias 2: Familiarity
The second bias, called familiarity bias, may cause some investors to be too concentrated on opportunities in their own countries. They are more familiar with and confident about local investment opportunities, so despite the fact that it’s much easier than in the past to diversify investments across geographies, they go with what they know and can easily understand.
Another example of familiarity bias is a tendency by investors to buy shares in the companies they work for. In doing so, the investor may become over-allocated to the company stock and the unsystematic risks that come from being under-diversified. Individuals that are over-allocated to company stock take the risk of having their assets and their income significantly reduced should the company go through a period of financial difficulty. To weed out familiarity bias, a good approach for the New Year would be to discuss different investing strategies than you typically use with your financial adviser and then consider employing those that are appropriate for meeting your unique financial goals
Bias 3: Anchoring
A third and final bias I want to touch on is the idea of anchoring, or becoming fixated on past information and using that information to make inappropriate investment decisions.
When investors are influenced by this bias, they may not be able to get their mind off a particular sell-price target, even if new information is available or the investing landscape has shifted significantly. They become stuck and may even ride markets to the bottom if they cannot let go of what they think the price “should” be.
One thing to remember said by one of the experienced trader
"Psychologically we as human beings are habituated to expect mercy and leniency right from our childhood. If we dont do our homework, teacher will punish us but not injure us....if we dont get good grades in school/college our parents will give punishment but will fergive us soon...in a job if we do mistakes, our boss does not kill us. All these things have mercies because we are dealing with living beings on the other side.
Market is a non living thing. It has no idea of your position, your loss, your hardships. So it has no mercy...it can ruin the life,families. Not respecting risk is like jumping in front of a running train and expecting the train to be lenient and not harm you much....".
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