Investing Basics: Overcoming Behavioural Biases When Investing

For those looking to increase their wealth, stocks are one of the best methods. Many people will use stocks to help generate extra money but it can also be difficult – guest post by Harry Turner

 
The issue that most investors have is that they let their emotions dictate their investments. Maybe they have grown a bond with a company or have lost money and are waiting for it to turn into a profit. Due to our emotions, they can soon remove the logic behind investing.

Our brains and instincts can make decisions for us based on bias. This makes it very difficult to avoid these decisions and can be overwhelming. Previous experiences and your gut feeling may also dictate your investment decisions.

Avoiding your emotions when making investment decisions can be difficult, however, if you can avoid these emotions, you can make a lot of money from investing.
 

How To Overcome Initial Instincts When Investing

 
Overcoming your initial instincts will be difficult but that is the part of learning. Furthermore, our initial emotions affect our reactions. For example, if we sense danger or panic, our emotions can impact our actions.

The issue we face when trading is that behavioural biases can impact our decisions. These impulsive decisions can do more harm than good, which is why it is important to not react in the moment.

A good example is when you go food shopping when you are hungry. You will notice you spend more money on food in the shop. This is an example of emotions dictating your actions.

Our investments are guaranteed to fluctuate which is what causes us to react the way it does. Sometimes, we can sell a stock investment due to an automatic reaction. Instead, you should wait until your emotions settle. There is no perfect time to sell a stock. No matter what the value is.
 

Cognitive Biases When Investing

 
Many behavioural biases can cause our reactions however some can be more common with investors than others.
 

Availability Bias

 
Availability bias is a very common type of behavioural bias among investors. This is when an investor will be more cautious because of recent experiences. This is completely normal for an individual, not just for investors. However, in an investor’s case, this can impact their decisions because they don’t want to lose money. Try to avoid previous experiences dictating your investment decisions as it is very likely it can be different to the other experiences. Teach investment differently.
 

Herd Mentality

 
Herd mentality is something else that is very common among investors. People will do what other people do and that has just been the way humanity has always been. Think of fashion trends, if there is a selective group where a certain item of clothing, you can be sure that other people will follow them and wear it themselves. This is the same as investing.

The problem with following other investors is that it can be counterproductive. For example, if a stock decreases in value very quickly, many people will sell their stock because they don’t want to lose money. The same issue occurs when a stock value increases significantly. Investors will buy into the stock and soon the stock can become overvalued. This bubble will soon burst and then shortly after, you lose a lot of money. Warren Buffet, 6th on the Forbes rich list for 2024, has said that you shouldn’t follow what the crowd does. You should rely on your own decisions and not other people’s. Just because more people are buying or selling a stock doesn’t mean you should. Your goals could be different to the others.
 

Endowment Effect

 
Some investors believe too much in their investment, they will think that their stock is better than others in the market including competitors, without any real research into it. They have just found a stock that others are investing in or have seen do well in recent weeks.

An example of endowment is when someone buys an item of clothing, they will likely sell the item for a more expensive price to gain profit. However, if they are given a ticket, they will probably sell it for market value. This is the same with stocks because you have bought into a stock, you can be reluctant to sell it for a lower price, even though the lower price is a more accurate representation of the true value.
 

Confirmation Bias

 
Confirmation bias is another common type of behavioural bias. When seeking more information, we often search for information that aligns with our beliefs. If there is information that is provided to us that we don’t align with what we think, we will tend to ignore it. This can be a very narrow mindset and can impact your financial decisions.

Researching stocks can be where confirmation bias takes place. For example, if you know about a stock but have recently gone through a rough patch, you will still invest in this stock because you know it has been a top performer in the past, you will ignore the news about its downfall and proceed to invest in it.
 

Summary: How To Avoid Behavourial Biases

 
Behavioural biases are completely natural. It is something we all experience, whether that is with life decisions or investing. However, there are things you can do to avoid these behavioural biases. No matter what the reaction is, it can also lead to mistakes such as trading scams. Following the crowd can leave you vulnerable to these scams which is why you must be cautious. Complete your research before you invest to be smart with your decision.

To stop these behavioural biases, you need to identify them before you try to fix them. As soon as you have identified them, you will know how to avoid them. You won’t let them intrude on your actions, allowing you to make more logical decisions with your investments. This is how you can start to build wealth, by not letting the crowd or your previous experiences intrude on your investments.