Stock

Markets and
Decision
Making
Dr. Manoj Pareek
E Mail: manoj.pareek@bennett.edu.in
“One of the funny things about
the stock market is every time
one person buys, another sells,
both think they are smart.”

- WILLIAM FEATHER
What we will discuss today
This webinar is about decision making while investing or trading in Stocks .

We will not go into analysis for picking or buying stocks which is namely

Fundamental Analysis – Looking into Financial Information of company ( P& L Account, Balance
Sheet, Cash Flow Statement) to determine the value of the stock of a company

Technical Analysis - Looking into share price patterns , volume traded , change in share price etc.
to predict prices . Generally, for a shorter duration.

The agenda today is to look into the psychology of investing and use it to our advantage
Understanding what investing is ?

The goal for investing ,trading and speculating is the same: to make money
Difference between Trading and Investing
Investors normally have a longer time horizon in mind. This is typically more than a year.
Traders, on the other hand, normally hold onto their assets for short time frames. This can be as
little as a few minutes.
Where is potential for loss is more ?
Difference between Speculation and Investing
The investment aims to grow wealth over the long term while minimizing risk. In contrast, the
main objective of speculation is to make quick profits by leveraging market fluctuations.
Quiz ( Case 1)
Suppose I provide you with Rs. 50000 each to invest in stocks

Case 1 :

Option 1 : You have a guaranteed profit of Rs.25000

Option 2: You have 50% chances of having a profit of Rs. 75000 and 50% chance to have Rs 0
profit

Which will you opt for ?

If you choose option1 you exhibit Risk Averse Behavior

If you have chosen option 2 you exhibit Risk Seeking Behavior

Quiz ( Case 2)
Suppose again I provide you with Rs. 50000 each to invest in stocks

Case 1 :

Option 1 : You have a guaranteed loss of Rs.25000

Option 2: You have 50% chances of having a loss of Rs. 45000 and 50% chance to have Rs 0
Loss

Which will you opt for ?

If you choose option1 you exhibit Risk averse Behavior

If you choose option1 you exhibit Risk Seeking Behavior

Some Learnings
Different people think differently while investing in markets

Everyone has different personality traits and behavior resulting in different results from
investments in stocks (gains and losses)

Success and failure in stock investments is dependent on decisions and actions we take while
investing and not only on knowledge of stocks and finance.
Is Investing simple ?
Looks like so

Buy Low and Sell High and make money ….

Buying stocks of good companies at reasonable prices with the expectation of reasonable return on investment

Investing Decisions involve

---- Buyand Sell decisions

---- Choice of Stocks
--- Length of Time to hold the stock
 Behavioral Finance
Behavioral finance is a field that studies how psychological, human biases and emotions influence
financial and investment decision-making.

Behavioral finance studies what you are as an individuals, how others behave and make decisions.

Main challenge being risk associated while making investing decisions.

FINANCE + PSYCHOLOGY = BEHAVIORIAL FINANCE

Traditional versus Behavioral
Finance
.
Human Nature coming into play
while investing
Greed and fear drives decisions

People are generally lazy and look for f short cuts

Humans are ambitious

Selfish

Humans are ignorant at times

Ego plays are role in decision making

Law of Sow and Reap as applicable to investing
Law of sow and reap’ is something which best exemplifies karma,

where it is well said, ’Whatever you will sow today, you will reap in the future.’

The three laws of ‘sow and reap strategy’ –

1. You have to sow before you reap –

2. You will reap what you sow –

3. You will reap more than you sow

Challenges in Investing
Some Biases in Investing

 LOSS AVERSION BIAS

 SELF SERVING BIAS

 HERDING

 CONFIRMATION BIAS
Selling your winners and holding your
losers is like cutting the flowers and
watering the weeds.”

- Warren Buffet
 Loss Aversion Theory
Loss aversion is a tendency in behavioral finance where investors are so fearful of losses that they focus on
trying to avoid a loss more so than on making gains.

Research on loss aversion shows that investors feel the pain of a loss more than twice as strongly as they feel
the enjoyment of making a profit.

Many investors mistakenly sell winners early and keep losers, a behavior driven by common psychological
biases such as loss aversion and overconfidence.

Logically Investor should hold the winning stock to win more and sell the losing stocks to keep losing more
Self Serving Bias
A self serving bias is a tendency in behavioral finance to attribute
good outcomes to our skill and bad outcomes to sheer luck.
Put another way, people choose how to attribute the cause of an
outcome based on what makes them look best.
Then, when things don’t go according to plan, clearly we’ve just had
bad luck.
Herding
Herding investors make their judgments on the purchase and sale of stocks based on the actions
of the majority of other investors in the market

According to the research, herd mentality exists in the market both when it was goes up and
when it was goes down.

In addition, the herding effect causes considerable increases in both the volume and the volatility
of the market.
Confirmation bias

Confirmation bias is an investor’s tendency to believe and seek information that

supports his perceived notion and avoid others. Because of confirmation bias, the
investor may neglect information which does not match his belief.
Example
For instance, Ram invested in the XYZ company after thorough research. He was
highly optimistic about the company and thought of staying invested in it for at
least ten years. He got the news of some serious litigation liability that may cause
the company to declare bankruptcy.
However, he intentionally ignored it because the information was not supporting
his perceived notion of the company’s strength. It suggests confirmation bias.
 Tip for rising markets- Cash is king and never be
100% invested

By holding money or keeping aside in Cash investor can buy stocks in event of sudden dips in
market or a correction when good stocks are available at reasonable prices .

If an investor has invested all then he will not be able to take advantages of opportunities to buy
stocks at lower prices as no cash is available .
Some books to read on Behavioral
Finance
 Beyond Greed and Fear Understanding Behavioral Finance and the Psychology of Investing

by Hersh Shefrin

The Little Book of Behavioral Investing: How not to be your own worst enemy James Montier –

 The Psychology of Money by Morgan Housel

 Behavioural Finance: Insights Into Irrational Minds and Markets by James Montier