Behavioral Biases

• Behavioural biases are irrational beliefs or behaviours that can

unconsciously influence our decision-making process. 
• Traditional economic theory is based on the rational man, However, it is
important to remember that in reality, humans will not always act
rationally. 
• Behavioural economics acknowledges this difference – Thaler’s Nobel Prize
was awarded for creating a ‘more realistic analysis of how people think and
behave when making economic decisions.’
• Our decisions can easily be affected by biases, especially when it comes to
money. This is why it is important for investors to be aware of these biases
and to consider them when making investment decisions.
 Overconfidence Bias
• Overconfidence bias is the tendency for a person
to overestimate their abilities.
• Overconfidence bias may lead clients to make risky
investments. In investing, overconfidence bias
often leads people to overestimate their
understanding of financial markets or specific
investments and disregard data and expert advice.
This often results in ill-advised attempts to time
the market or build concentrations in risky
investments they consider a sure thing.
 Heuristics Bias
• A heuristic is a mental shortcut that allows
people to solve problems and make
judgments quickly and efficiently. These
rule-of-thumb strategies shorten decision-
making time and allow people to function
without constantly stopping to think about
their next course of action. Heuristics are
helpful in many situations.
 Representative Bias
• “It means the managers assess the likelihood of an event based on its
closeness to the other events, it is called Representation Bias”
• Representation bias occurs through memory recall. When a decision
maker has to analyze the options of a decision, he tends to recall a
memory or experience that is similar to the present decision-making
situation. In the representative heuristic we compare the similarity of
two objects and assume that one is like the other .
• The representativeness heuristic argues that people see commonality
between items or people of similar appearance, or between an object
and a group it appears to be a part of.
 Anchoring and Adjustment Bias
• Anchoring and adjustment refers to the cognitive bias wherein a
person is heavily dependent on the piece of information received
initially (referred to as the “anchor”) while making all the subsequent
decisions.
• In other words, all the subsequent decisions are influenced and require
adjustments to remain close to the initial anchor value, which can be a
cause of a problem if the anchor is too different from the true value.
• This type of bias typically is seen when an individual builds future
outcomes based on past available information.
 Cognitive Dissonance Bias
• The term cognitive dissonance is made
up of two words, i.e., cognitive, which
means relating to the brain, and
dissonance, which means turmoil or
discomfort. Hence, cognitive dissonance
bias is related to the mental discomfort
which investors have to go through if
they have to hold two conflicting views
about the market in their minds.
 Availability Bias
• This is a cognitive and information processing bias, where
investors use a shortcut, based on how familiar the outcome
appears in their life.
• They perceive easily recalled possibilities as the best choices.
• Examples:
• 1). A technology company employee will think technology
• companies are the best investments without due diligence
• and research.
• 2). An investor may avoid investing in countries for the sole
• reason that the country’s name is not easily recalled.
• 3). Investors tend to think well-advertised mutual funds are
• the best because of “retrievability.”
 Illusion of Control Bias
• It describes the tendency of human beings
to believe that they can control or at least
influence outcomes when, in fact, they
cannot. When subject to illusion of control
bias, people feel as if they can exert more
control over their environment than they
actually can.
• People think they are better guessers when
they correctly pick a number of coin tosses
in a row. (This also applies to investors
correctly trading or speculating in
individual stocks.)
 Endowment Bias
• The endowment bias describes
how people tend to value items
that they own more highly than
they would if they did not belong
to them. This means that sellers
often try to charge more for an
item than it would cost elsewhere.
 Confirmation Bias
• Confirmation bias occurs when people ignore information that
contradicts their existing beliefs. At the same time, they search for
information that re-affirms those beliefs and views – thereby rejecting
new information that is contradictory. In other words, they search for
information that confirms they are right and ignore information that
suggests they are wrong.
• Confirmation bias is partially driven by ego. Nobody likes to be wrong
after believing is something after so long.
 Optimism Bias
• The Optimism Bias describes our tendency to
predict the future with rose-tinted spectacles,
in that we overestimate our likelihood of
experiencing good life events and
underestimate the likelihood of suffering
negative events. More simply, people think
they’ll be luckier than they are likely to be.
Neuroscientists estimate that around 80% of
us are affected by optimism bias to some
degree.
Characteristics of extremely successful investor

Knowledg Goal
e Setting

Investor
Right
Petience
Decistion
Risk
Aversion
Characteristics of extremely successful investor
1) Goal setting - Having a plan of action within a defined period of time for a
particular return on investment is a sign of a good investor. They are prepared
for the uncertainty of the market while the plans are usually made considering
both the sides 
2) Knowledge - He/she understands the position of funds and has researched
about the company investment strategy and philosophy. You need to know
where your money is being utilized. A good investor analyses the growth
pattern of the company over the years from genuine sources. 
3) Right Decision - A good investor knows the time. They keep an eye on current
scenario in the market. They update their knowledge about market activities
and growth. Having a sound understanding of trends enables the investors to
overlook their plans and decide the term of investment.
Characteristics of extremely successful investor
4) Patience - A good investor has faith in his plans. They usually do not
feel bad about the 10% downtick; they would rather sit tight to
celebrate the 100% uptick. They are persistent about sticking to the
plans. They usually do not get into the buy and sell trends.
5) Risk Aversion - Good investors know the inherent risk in investing.
They understand their plans and analyze their expected returns. Being
risk averse is a quality shaped by experience, knowledge and
confidence over the above mentioned key characteristics.
 Investor
• An investor is either an individual or a business entity or a financial
entity who takes their financial capital and invests it in a particular
commodity, currency, or company in hopes of getting some of
financial returns in the future. A company can be an investor, and
even a mutual fund can be called an investor.
• Before they are categorized into their different subtypes, an investor
is first categorized based on two main categories –
1) Active investor and
2) Passive investor.
 Active and Passive Investor
• Active Investor - An active investor is someone who constantly checks
the market for amazing investment opportunities and has made
investing an integral part of their life. For example, investors like a stock
market investor and a cryptocurrency investor can be categorized as
active investors.
• Passive Investor – On the other hand, a passive investor is an investor
that makes long-term investments that may have poor value at the
start but hold a lot of value potential for the future and can serve as an
excellent investment opportunity if you are willing to wait for a long
time. An investor like a mutual fund investor and a real estate investor
often come under this category.
 Angel Investors
 An angel investor is an investor that has amassed massive amounts
of wealth and revenue for themselves.
This investor earns an income that is 3x-4x or even more than the
income of most successful average men.
Their net worth is often found to be in millions, and they are an
investor who can be found anywhere in the industry sector.
An angel investor primarily invests in first-time business companies
and start ups by purchasing large amounts of their shares.
 P2P Lenders
 P2P lenders are investors, or groups of investors, that help small
businesses get a chance with their products and services in the
financial market.
These lenders are specialized in this type of investing, and if a
business wants their financial help, they need to appeal to them by
themselves.
If they like the business idea and think it has potential, these lenders
personally fund the ventures of small businesses and purchase their
shares.
 Personal Investor
A personal investor is an individual investor that invests their capital
in a business company, or any investment opportunity for that matter,
for their own personal gain.
They do not represent a group, nor do they invest only in small
ventures particularly, but everywhere they see a chance of
investment.
If these types of investors were to invest in businesses, they need to
go through a rigorous documentation process to do so.
 Banks
 Banks are investors as well, but they invest in a different way than
individual investors.
Banks provide businesses, companies, and individual loans that act as
their “investment.”
This investment gets a fixed monthly return which is increased by the
interest rate charged by the bank.
If a business is looking for financing through investing, opting for
loans from their local banks is their best choice.
 Venture Capitalists
A venture capitalist is an investor that invests in a business or
company only and only if the said business has an idea or growth rate
that has the potential of becoming immensely successful one day.
If a business shows signs of rapid growth in the future, a venture
capitalist will be the first investor to invest a large amount of capital in
the business by purchasing an equity stake.
 Bubbles and Systematic Investors
sentiments
• A bubble is an economic cycle that is characterized by the rapid
escalation of market value, particularly in the price of assets.
• This fast inflation is followed by a quick decrease in value, or a
contraction, that is sometimes referred to as a "crash" or a "bubble
burst."
• Bubbles are typically attributed to a change in investor behavior,
although what causes this change in behavior is debated.
• Bubbles in equities markets and economies cause resources to be
transferred to areas of rapid growth. At the end of a bubble,
resources are moved again, causing prices to deflate.
 Bubbles and Systematic Investors
sentiments
• An investor sentiment is the propensity to speculate. Under this definition,
sentiment drives the relative demand for speculative investments.
• What makes some stocks more vulnerable to broad shifts in the propensity to
speculate? the main factor is the subjectivity of their valuations.
• For instance, consider a canonical young, unprofitable, extreme growth stock. The
lack of an earnings history combined with the presence of apparently unlimited
growth opportunities allows unsophisticated investors to defend, with equal
plausibility, a wide spectrum of valuations, from much too low to much too high,
as suits their sentiment.
• During a bubble period, when the propensity to speculate is high, this profile of
characteristics also allows investment bankers (or swindlers) to further argue for
the high end of valuations.
 Bubbles and Systematic Investors
sentiments
• By contrast, the value of a firm with a long earnings history, tangible assets, and stable
dividends is much less subjective, and thus its stock is likely to be less affected by
fluctuations in the propensity to speculate.
• Investors simply demand stocks that have the bundle of salient characteristics that is
compatible with their sentiment.
• That is, investors with a low propensity to speculate may demand profitable, dividend-
paying stocks not because profitability and dividends are correlated with some
unobservable firm property that defines safety to the investor, but precisely because the
salient characteristics “profitability” and “dividends” are essentially taken to define
safety.
• Likewise, the salient characteristics “no earnings,” “young age,” and “no dividends” mark
the stock as speculative.
• Casual observation suggests that such an investment process may be a more accurate
description of how typical investors pick stocks than the process outlined by Markowitz
(1959), in which investors view individual securities purely in terms of their statistical
properties.