Dear Reader,

Registration with the Sri Lanka FINANCIAL CHRONICLE™️ would enable you to enjoy an array of other services such as Member Rankings, User Groups, Own Posts & Profile, Exclusive Research, Live Chat Box etc..

All information contained in this forum is subject to Disclaimer Notice published.

Thank You

Join the forum, it's quick and easy

Dear Reader,

Registration with the Sri Lanka FINANCIAL CHRONICLE™️ would enable you to enjoy an array of other services such as Member Rankings, User Groups, Own Posts & Profile, Exclusive Research, Live Chat Box etc..

All information contained in this forum is subject to Disclaimer Notice published.

Thank You
Would you like to react to this message? Create an account in a few clicks or log in to continue.

Encyclopedia of Latest news, reviews, discussions and analysis of stock market and investment opportunities in Sri Lanka


Submit Post




View results

ශ්‍රී ලංකා මූල්‍ය වංශකථාව - සිංහල
Submit Post


Send your suggestions and comments

* - required fields


Latest topics

» Misuse of government property by Royal Colombo Golf Club
by ChooBoy Yesterday at 12:52 pm

» SL Cauvery and Mannar Basins Petroleum Resource Data Revealed
by samaritan Yesterday at 12:00 pm

» Expolanka to continue its winning streak
by samaritan Yesterday at 10:39 am

» Container shipping stocks routed
by target1 Fri Jun 24, 2022 1:32 pm

» Supply Chain Latest: Ocean Freight Rates Are Falling
by target1 Fri Jun 24, 2022 1:26 pm

» Turkish ship leaves Ukraine's Mariupol after grain talks with Moscow
by target1 Fri Jun 24, 2022 11:29 am

» This week's CBOT corn, soy freefalls hard to match in recent years
by target1 Fri Jun 24, 2022 9:57 am

» Positive news to boost market sentiment
by samaritan Fri Jun 24, 2022 9:52 am

» Maharaja at IMF meeting
by Maharaja Thu Jun 23, 2022 10:35 pm

» Why no power cuts in certain areas of Colombo?
by samaritan Thu Jun 23, 2022 5:44 pm

» India assures fullest support to Sri Lanka as a close friend
by samaritan Thu Jun 23, 2022 5:17 pm

» SINS, SAMP, COMB, PARQ, ALUMEX and AEL - are they good shares to start collecting now?
by surfjj Thu Jun 23, 2022 4:25 pm

» Learn how a fixed exchange rate system can be used to reduce inflation.
by target1 Thu Jun 23, 2022 3:35 pm

» Debt Crisis: Sri Lanka Vs Argentine
by CHRONICLE™ Thu Jun 23, 2022 8:17 am

» Sri Lanka in state of panic 1 month after sovereign default
by reyaz Tue Jun 21, 2022 5:23 pm

» Financial stability - we are at the crossroads.
by sheildskye Tue Jun 21, 2022 2:17 pm

» Shrinkflation: Is it ethical?
by sheildskye Tue Jun 21, 2022 2:05 pm

» Banking bullish billionaire Ishara expands footprint
by samaritan Tue Jun 21, 2022 10:58 am

» SL hopes to finalize a staff level program with IMF soon-RW
by samaritan Tue Jun 21, 2022 9:48 am

» Sri Lanka Stock Market heading toward ASPI 4500
by samaritan Tue Jun 21, 2022 9:29 am








You are not connected. Please login or register

FINANCIAL CHRONICLE™ » CHRONICLE™ ANALYTICS » An introduction to behaviourial finance

An introduction to behaviourial finance

Go down  Message [Page 1 of 1]

1An introduction to behaviourial finance Empty An introduction to behaviourial finance Wed Oct 19, 2011 1:57 pm



From Investopedia

It's hard not to think of the stock market as a person: it has moods that can turn from irritable to euphoric; it can also react hastily one day and make amends the next. But can psychology really help us understand financial markets? Does it provide us with hands-on stock picking strategies? Behavioural finance theorists suggest that it can.

Beliefs and findings of behavioural finance

This field of study argues that people are not nearly as rational as traditional finance theory makes out. For investors who are curious about how emotions and biases drive share prices and markets, behavioural finance offers some interesting descriptions and explanations.

The idea that psychology drives stock market movements flies in the face of established theories that advocate the notion that markets are efficient and rational. Proponents of efficient market hypothesis say that any new information relevant to a company's value is quickly priced by the market through the process called arbitrage.

This is where someone spotting a stock that is too cheap or too expensive takes advantage of the difference between the real value and the market one and as new information is widely available, it efficient market theory means that a change in circumstances is quickly jumped on and exploited until the stock or commodity reaches its 'fair' value and stops moving — at least until something new is discovered and the process starts again.

For anyone who has been through the Internet bubble and the subsequent crash, the efficient market theory is pretty hard to swallow. Behaviourists explain that, rather than being anomalies, irrational behaviour is commonplace. In fact, researchers have regularly reproduced market behaviour using very simple experiments.

Importance of losses versus significance of gains

Here is one experiment: offer someone a choice of a sure £50 or, on the flip of a coin, the possibility of winning £100 or winning nothing. Chances are the person will pocket the sure thing. Conversely, offer a choice of a sure loss of £50 or, on a flip of a coin, a loss of £100 or nothing. The person will probably take the coin toss.

The chance of the coin flipping either way is the same in both scenarios, yet people will go for the coin toss to save themselves from loss even though the coin toss could mean an even greater loss. People tend to view the possibility of recouping a loss as more important than the possibility of greater gain.

The priority of avoiding losses holds true also for investors. Just think of Northern Rock shareholders who watched their stock's value plummet from more than £12 a share in early 2007 to nothing by early 2008 when the bank was nationalised. No matter fast the price dropped or how much it was in the news, investors, believing that the price would eventually come back, not only held onto the stocks, but some even started buying more shares.

The herd versus the self

Herd instinct explains why people tend to imitate others. When a market is moving up or down, investors are subject to a fear that others know more or have more information. As a consequence, investors feel a strong impulse to do what others are doing.

Behavioural finance has also found that investors also tend to place too much worth on judgments derived from small samples of data or from single sources. For instance, investors are known to attribute skill rather than luck to an analyst that picks a winning stock.

On the other hand, investors' beliefs are not easily shaken. One belief that gripped investors throughout the late 1990s was that any sudden drop in the market was a good time to buy. Indeed, this view still pervades. Investors are often overconfident in their judgments and tend to pounce on a single "telling" detail rather than the more obvious average.

How practical is behavioural finance?

We can ask ourselves if these studies will help us beat the market. After all, rational shortcomings ought to provide plenty of opportunities for people wise to them. In practice, however, few people — if any — are deploying behavioural principles to sort out which cheap stocks actually offer returns that can be taken to the bank. The impact of behavioural finance research still remains greater in academia than in practical money management.

Perhaps one telling conclusion from all the research is not to trust the market value or past performance of a stock or commodity. This conclusion is, of course, nothing new. It's what billionaire investor Warren Buffet has based his fortune upon. In a recent example, he pumped money into Goldman Sachs bank at the height of the credit crisis that swallowed up fellow investment banks Bear Stearns and Lehman Brothers in 2008.

While others frantically followed the market in a herd and sold shares in all the investment banks, driving all their share prices lower, Buffet saw a good bank. He made billions from the deal by bucking the market trend. However it's not an easy trick to repeat.

While it points to numerous rational shortcomings, the field offers little in the way of solutions that make money from market manias. Robert Shiller, author of 'Irrational Exuberance' (2000), showed that in the late 1990s the market was in the thick of a bubble. But he couldn't say when it would pop. Similarly, today's behaviourists can't tell us when the market has hit bottom. They can, however, describe what it might look like.

The bottom line

The behaviouralists have yet to come up with a coherent model that actually predicts the future rather than merely explains, with the benefit of hindsight, what the market did in the past. The big lesson is that theory doesn't tell people how to beat the market. Instead, it tells us that psychology causes market prices and fundamental values to diverge for a long time.

Behavioural finance offers no investment miracles, but perhaps it can help investors train themselves how to be watchful of their behaviour and, in turn, avoid mistakes that will decrease their personal wealth.

Ben McClure, 15:11, Tuesday 18 October 2011;_ylt=AtoprJTJ1oH2qJly72zLT1DSr7FG;_ylu=X3oDMTFjZmZpajA5BHBvcwMzBHNlYwN5ZmlXZWVrZW5kVGFrZW92ZXIEc2xrA3JlYWRtb3JlMTg3

@ moderators please move to the appropriate section if you need.

Back to top  Message [Page 1 of 1]

Permissions in this forum:
You cannot reply to topics in this forum