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The Psychology of Investing
"Ben Graham's conviction rested on certain assumptions. First, he believed that the market frequently mispriced stocks. This mispricing was most often caused by human emotions of fear and greed. At the height of optimism, greed moved stocks beyond their intrinsic value, creating an overpriced market. At other times, fear moved prices below intrinsic value, creating an undervalued market".
Robert G Hagstrom
Investing is often referred to as an art not a science. One of the main reasons for this is the behavioural patterns of investors and how the decisions they make are influenced by certain events and the human traits that lead to those decisions. A field known as “Behavioural Finance” has evolved in an attempt to understand how emotions and cognitive errors influence investors and the decision making process. To be a successful investor we need to firstly understand our own “emotional” make up and then ensure that our decision making process is allowing for the fact that these factors will be involved in the process, after all we are human.
Fear and greed are the two most commonly referred to by people that follow markets however, there are others.
People tend to give too much weight to recent experience and extrapolate short term trends which is against what will happen over the long term. Professor Schiller studied this phenomenon and found that at the height of the Japenese share market 14% of investors expected the market to crash. After it did crash the amount of investors expecting it to crash rose to 32%.
As investors people need to discern between skill and what was luck. Human nature is to say that good results are that of skill whist bad results are that of bad luck. It is important to remember that the future is uncertain and unknown and when you make a decision it is based on the information you have at the time. If investors expect to know what events will transpire in the future, like a global financial crisis the extent that we have seen, then they are bound to fail.
Ego, confidence, ability to blame others, regret are all factors that influence our cognitive decision making process to be an investor we must understand our decision making process if we are any chance of making good decisions.
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