Behavioural finance studies how psychology distorts investment decisions. Loss aversion, anchoring, herding, and overconfidence cause investors to underperform. Recognising these biases is the first step to overcoming them.
Answer: Feel the pain of a loss more intensely than the pleasure of an equivalent gain. Kahneman & Tversky showed losses feel roughly 2x more painful than equivalent gains feel pleasurable.
Answer: Relying too heavily on the first price seen (e.g., purchase price) when making decisions. Investors anchor to original purchase prices — refusing to sell at a loss even when the rational decision demands it.
Answer: Bubbles and crashes as investors blindly follow the crowd. When investors follow each other blindly, assets become wildly over or undervalued — creating bubbles and crashes.
Answer: Hold losing positions and sell winning positions too early. The disposition effect: investors sell winners to "lock in" gains and hold losers hoping to recover — the exact opposite of optimal.
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