BIASES

Individual biases often do not have a large enough effect to change market prices and returns.

To understand market behaviour and price action, behavioural researchers look at several human and social cognitive and emotional biases such as:

• Overconfidence in your own abilities as a trader or investor and overreaction to newly arrived information
• A biased market view (meaning the persistence of one’s trading strategy even when such strategy is failing or ignoring new information that may contradict one’s trading decisions)
• Loss aversion (it is empirically proved that people prefer to avoid losses than acquire gains)
• Money illusion (refers to the fact that people do not think of currency in real terms but in nominal terms)
• Fear of regret (which causes investors to hold losing positions too long in the hope that they will become profitable, or liquidate winners too soon to lock in profits before they turn into losses)
• Marginal utility of money (where the seed capital is more valuable than additional gains)
• Inability to use complex rather than linear reasoning (meaning a rational attribution of market reaction to specific causes) and various other predictable human errors in reasoning and information processing.

A good example of the rational attribution to specific causes is seen in the daily reporting of news. The mainstream financial media tends to explain what happened rather than what is about to happen. In any case, price action is always reported as being due to some sound and reasonable cause. If the market is up, reasons as to why it is up are selected, and if it is down, then various reasons are also found to explain it. The media tells the crowd what they want to hear, because it is made by reporters, not traders. So, the obsessions of the reporters are mirroring those of the crowd.