What is Investor Psychology?
What is Investor Psychology
What is Investor Psychology?
Psychology is the branch of science that studies human behavior and mental processes; It covers topics such as consciousness, emotion, perception, learning, memory and development. The main purpose of psychology is to understand, explain and control human behavior. Psychology can affect investment decisions, as in every aspect of life. In other words, a decision implemented in the capital markets may depend on the investor's current psychology.
Behavioral finance is one of the sub-disciplines of finance that goes beyond traditional finance theory and focuses on understanding the reflection of investors' decision-making processes on the markets. This approach is based on the idea that market participants often behave in non-rational/unpredictable ways and tries to evaluate this situation through investor psychology. Traditional finance theory (Efficient Market Hypothesis) assumes that individuals act rationally, are rational actors who maximize returns, and make decisions by taking into account available information. Behavioral finance uses sciences such as psychology and sociology to explain abnormal price movements (anomaly, bubble) or behavior in financial markets.
Behavioral finance and investor psychology are two concepts close to each other. In other words, investor psychology forms the basis of behavioral finance. While investor psychology offers an approach to understanding investors' decision-making processes, behavioral finance investigates the reflection of these decision-making processes on financial markets. Investor psychology states that in scenarios where the level of risk or uncertainty increases, investors may deviate from rationality in their trading decisions by being influenced by past experiences, prejudices and psychological factors. In summary, investor psychology consists of the emotional and mental factors that affect the decision-making process of investors.
It is important for an investor to be able to manage his psychology as well as his technical and fundamental analysis skills. It is possible for investors who develop their emotional intelligence and psychology, recognize their prejudices and determine their risk perceptions to make more rational investment decisions.
What are the Biases That Affect Investment Decisions?
Confirmation bias is the tendency to ignore conflicting situations when searching for information about a particular capital market instrument, but to take into account information that confirms a pre-existing thought. This situation may prevent objective evaluation of investment options and possible risks, causing irrational decisions to be made.
attachment bias,
It is the situation in which the investor, while making a decision, adheres to the first information or reference point obtained for a particular capital market instrument, evaluates new inputs according to the reference point and makes an investment decision accordingly. In other words, the past performance of any capital market instrument may not be a guide to its future performance. Therefore, investors should focus on a broad range of data and avoid relying solely on historical inputs.
illusion of repetition,
is the tendency to attribute greater credibility to frequently repeated information. In other words, if an investor is constantly exposed to the same information, he tends to trust and attach more importance to this information.
The illusion of over-processing,
It describes the investor's tendency to make more purchases and sales transactions than usual, even though it is an irrational behavior, in scenarios where the level of risk or uncertainty increases. This bias can often stem from the fear of missing out on opportunities and the investor's desire to feel in control.
risk aversion bias,
It describes the tendency of investors to prioritize avoiding losses over achieving potential gains. This bias may lead to preference for an instrument perceived to have less risk, even if a lower potential return is offered. Risk aversion bias can lead to making irrational decisions, such as waiting for long periods of time or avoiding investments with high return potential due to fear of losing money.
Bias to avoid questioning,
It refers to the impairment of judgment due to anxiety about avoiding failure. The bias in question arises from the desire to realize profitable positions early or the tendency to not accept losses. In other words, it refers to the tendency to exit an asset that produces returns too early or to not give up a loss-making investment with the expectation that it will generate returns again.
self-esteem bias,
It refers to the tendency of investors to overestimate their abilities and the accuracy of their forecasts. In other words, it is related to investors taking riskier positions based on their past success or underestimating uncertainties in financial markets.
herd effect,
It refers to investors' tendency to follow the crowd. This bias can often result in irrational market behavior such as bubbles and crashes. In other words, it refers to the situation where investors tend to base their decisions on the behavior of other market participants and act on speculation and rumors.
It is important for an investor to be able to manage his psychology as well as his technical and fundamental analysis skills. It is possible for investors who develop their emotional intelligence and psychology, recognize their prejudices and correctly determine their risk perceptions to make more rational, long-term and sustainable investment decisions.
Investor psychology aims to help investors make more informed, emotionally balanced and strategic decisions. To successfully manage investor psychology, financial literacy as well as personal awareness must be constantly improved. Understanding the impact of emotions on investment decisions is the first step to managing them effectively. It is important to have self-control and discipline in this regard. Investors should determine their risk perception in advance and monitor their attitude to sudden market fluctuations or unexpected situations. Afterwards, the situation should be analyzed and steps should be taken in a long-term perspective. On the other hand, investors who constantly improve financial literacy, research capital market products, analyze market dynamics and have a specific investment strategy are less likely to be influenced by their emotions.
One of the most important factors in making irrational decisions is being stubborn with the markets. However, before making any investment decision, it is necessary to accept the profit-loss relationship from the beginning. The investment strategy determines what to do in case of profit or loss, that is, the game plan and provides a road map. In this way, stubbornness with the market can be prevented, the perception of profit and loss can be clarified more easily, and the possibility of making irrational decisions can be reduced by suppressing emotions such as greed and fear.
Another important factor in managing investor psychology is not to be affected by mass psychology. Successful investors make their own decisions and try to get returns from the action of the crowd. Although the mass determines the trend of the market, market participants who manage investor psychology correctly make decisions based only on their own ideas and analysis. Following the market is important for understanding the dynamics, but making investment decisions based on speculation, suggestions on social media, rumors and manipulative news can lead to erroneous results.
Rather than trying to time the market or focusing on short-term returns, the long-term investment approach focuses on the long-term potential growth of the portfolio. Investors who adopt long-term investment strategies are more likely to achieve their financial goals as well as avoid emotional psychological factors. On the other hand, asset allocation or diversification can reduce possible risks. A diversified portfolio helps investors focus on their long-term goals and reduces the likelihood of making impulsive decisions.
