1.) The endowment effect
We've all got that one stock that’s been a real winner for us. And it’s natural for us to feel emotionally attached to it.
But the problem arises when the holding period is up and it’s time to sell- no price seems good enough.
We've all got that one stock that’s been a real winner for us. And it’s natural for us to feel emotionally attached to it.
But the problem arises when the holding period is up and it’s time to sell- no price seems good enough.
And this is what the endowment effect is all about. Just because you own the stock, you’re emotionally biased towards it, and this makes you value the stock higher than its actual worth.
2.) The herding effect
Humans are a social species- this has allowed us to thrive for decades. But it also has a downside. It fosters the tendency to do things just because everyone is doing them. This has been evident historically, like in the dot-com bubble of the late 1990s.
Humans are a social species- this has allowed us to thrive for decades. But it also has a downside. It fosters the tendency to do things just because everyone is doing them. This has been evident historically, like in the dot-com bubble of the late 1990s.
Many dot-com companies did not have financially sound business models, but investors bought into them because everyone else was.
And this irrational herd mentality led to a massive bubble formation, which eventually burst, and the losses ran into millions.
And this irrational herd mentality led to a massive bubble formation, which eventually burst, and the losses ran into millions.
3.) Anchoring bias
This bias refers to the subconscious use of irrelevant information to make decisions. A fixed (or anchored) piece of information influences all subsequent decisions you make.
This bias refers to the subconscious use of irrelevant information to make decisions. A fixed (or anchored) piece of information influences all subsequent decisions you make.
For instance, if you see that a Fund X has outperformed over a 1-year timeframe, you decide to invest in it.
Your anchor here is its outperformance - a single piece of information that you have seen over a short span of time, which made you biased towards it.
Your anchor here is its outperformance - a single piece of information that you have seen over a short span of time, which made you biased towards it.
4.) Self-attribution
If a stock you just bought begins to fall, who do you blame? Maybe the friend who recommended it? Or perhaps the CEO of the company?
But if the stock begins to go up instead, you'd believe that it was your analysis that fetched you a good deal, right?
If a stock you just bought begins to fall, who do you blame? Maybe the friend who recommended it? Or perhaps the CEO of the company?
But if the stock begins to go up instead, you'd believe that it was your analysis that fetched you a good deal, right?
This is because as humans, we attribute positive outcomes to our own skills. And when the outcome is negative, we cut ourselves some slack by holding others accountable.
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