Behavioral finance – the secret of our crazy stock market decisions

Behavioral finance, also known as behavioral economics, is something like the quirky, unorthodox cousin of traditional finance theory. While traditional financial theory focuses on how rational, logical people make decisions, behavioral finance says: “Wait a minute, it’s not that simple!”
It looks at us – real people – with all our quirks, fears and idiosyncrasies. Behavioral finance examines how psychological factors influence our financial behavior. Why we sometimes act against our own interests, why we take risks when we should know better, and why we sometimes get carried away by the crowd.
As you can see, behavioral finance is not just dry theory, it is exciting, fascinating and sometimes a little crazy – just like us humans! But now let’s delve deeper and find out why we investors sometimes tick the way we do.

The crazy person behind the rational investor

I would like to use the following examples to explain why investors often act irrationally. This is absolutely human, but not necessarily beneficial for your investment.

Firstly, the thing about overestimating ourselves. You know, when we stand in front of the mirror and say: “Me, a financial genius? Of course!” This phenomenon is called overconfidence bias. We tend to overestimate our financial knowledge and our ability to process information. We think we have a sixth sense for the stock market, as if we can see through the matrix of the financial markets. But let’s be honest, this often ends up in decisions that are riskier than a game of Russian roulette.

Secondly, the infamous anchor effect. Imagine you hear about a stock that is currently storming the charts. You buy it, but then the information changes and the price falls. Nevertheless, you hold on to your initial assessment as if it were attached to an anchor. You ignore the new facts that point in a different direction and stick to your original decision. Anchors can be useful when you are on the high seas with a boat. In the stock market, however, they can lead you into a financial shipwreck.

Thirdly: loss aversion, the old spoilsport. If we lose CHF 100, we feel about twice as bad as we would feel good if we won CHF 100. It’s almost as if our brain is playing a trick on us, making life difficult. Losses hurt, no question about it. But if we let this fear guide us, we could miss out on great opportunities. The stock market is not a place for the faint-hearted, so let’s be a little braver, people!

Finally: herd behavior. You know how it is – when everyone runs in one direction, we run after them. When your aunt, your hairdresser and your neighbor all buy Bitcoin, you also feel tempted to jump on the bandwagon. But the stock market is not a sheepfold and we are not sheep. Blindly joining the crowd can lead to us falling off cliffs instead of grazing on green pastures.

To summarize: Yes, we investors are a crazy bunch. But if we recognize our quirks, we can get to grips with them and make smarter investment decisions. Because the world of the stock market is not just about facts and figures – it’s also about us and our often capricious human behavior.

How we can use our craziness to our advantage

But enough about all the crazy things we do. How can we use this to our advantage? First of all, by recognizing and accepting our quirks. I know it’s hard. But be honest with yourself: You’re not perfect. And that’s okay.
Once we know our weaknesses, we can control them and react better to market developments. And hey, maybe we’ll be less inclined to risk our entire savings on the next “sure thing.”
Understanding behavioral finance can help us understand the reasons behind market trends and anomalies. Why do prices rise and fall? Why are there bubbles and why do they burst? It’s not just a question of supply and demand. It’s about people. It’s about us.
So, dear investors, the next time you are faced with a financial decision, remember: you are not alone. We’re all a little crazy and irrational when it comes to money. But with a better understanding of our own emotional weaknesses, we can be better prepared and maybe even act a little smarter. Because in the world of behavioral finance, knowledge is definitely power!

With this in mind: be critical, not impulsive. To make smarter investment decisions, first identify your emotional tendencies, such as overconfidence or fear of financial loss, and consciously refrain from them. This will make you happier in the long term – financially too.

Yours, Mark Stock©

Mark Stock is a member of the Point Capital editorial team. “I am a stock market enthusiast and am passionate about economic history. I have been following the ups and downs of the markets for years and, of course, invest myself – preferably in shares. So my name says it all. Every month, I take up what I consider to be an exciting topic. And since the focus is on the content and not on me personally, I write under a pseudonym.”