Market Psychology

The importance of the psychological (or emotional) aspect of investing cannot be underestimated or ignored. The basis of much human error in the field of investing derives from the human tendency to employ and rely upon various rules of thumb… shortcuts (or biases) that humans use without even being aware that we are doing so. We apply these as it is instinctive within us to do so. These instincts are hard wired into the brains of humans and are unknowingly employed to enable us to make the right decisions based on the limited information available to us in many situations. However, such shortcuts can lead us astray under certain circumstances and the field of investing is one such area.

Many investors say things like "I can't sell XYZ because I bought the stock at higher levels" and "I like the company so I bought it". This highlights the emotional impact of investors on their decision-making process. Investing should never be an emotional process, but rather it should be a rational one. But unfortunately, we are emotional animals, so discipline and awareness of our flaws is exceedingly important. Following is a look at the specific shortcuts and biases, also known as cognitive illusions (doesn't this term tell us how misleading our instincts can be), that can lead us astray in the stock market.