Know these behavioural biases before investing
Emotional biases can cause investors to make sub-optimal decisions. A few of the significant biases are discussed here:
Loss aversion: Investors tend to prefer avoiding losses as opposed to achieving gains. This bias says that losses have more significance for an investor than an equivalent amount of gain. A rational investor should accept more risk to increase gains. Mitigating losses should not be the main aim of investing. Loss aversion leads people to hold their loser stocks longer even if the investment has zero or little chance of showing improvements. Individual investors tend to suffer a lot from this bias.
Overconfidence bias: Investors, sometimes, demonstrate unwarranted faith in their intuitive reasoning and cognitive abilities. This overconfidence in one’s decision may be harmful as one may have incomplete knowledge and still feel confident about it.
There are two basic types of overconfidence bias: Prediction overconfidence and certainty overconfidence. This kind of bias may result in underestimation of risks and overestimation of expected return, excessive trading, and poorly diversified portfolio. Investors should review their trading records, identify winners and losers, and calculate portfolio performance over at least 3 years. This will make one aware of one’s skill level of identifying winners and also give an idea of the amount of the trading done.