Investors go through the cycle of buying a stock then holding on to it and finally selling the stock. Each of these stages are full of behavioral pitfalls which can significantly impact your returns. You can have the best investment processes or advisers but these behavioral biases have to be dealt by yourself. Succeeding over them will almost guarantee multibagger returns (provided other processes are in place). This is the single biggest differentiating factor why only a few people realize multibagger returns. In this article, we will discuss some prevalent behavioral biases so that you can refine your own investment behavior.
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Stock market is a machine of transferring shares (& wealth) from one hand to another seamlessly. There are only finite number of shares of a company listed on a stock exchange. Everyday someone decides to buy and someone else decides to sell that stock. It is very interesting how different people take different decisions using same set of publicly available information. Since information is same for everyone, still people take contrasting decisions, there must be something more than just fact-based decisions. This is where our behavioral aspect comes into play. If investors were all programmed computers, everyone will take same decision and there would be no trade possible (this happens in case of algorithm trading). Luckily, we humans are curious by nature & everyone has different opinion, leading to diversity of trades which ensures liquidity in the market.
Benjamin Graham in his famous book ‘The Intelligent Investor’ wrote that markets are more psychological than logical. There are a number of behavioral biases that plagues all of us, even analyst & experts also suffer from it to some degree. Below are some biases that we as investors should be mindful.
- Confirmation Bias: It is the tendency to invent reasons to justify our biased belief in a particular stock. Sometimes, we like a stock due to some reasons and then our mind is always on a look out to find supporting reasons. In this process, we often ignore alarming signs which can be damaging.
- Ownership Bias: We think everyone suffers from this. How often we think that stock in our demat account is the best. This bias creeps in from our prideful nature in which we hang on to a stock irrespective of demerits of it.
- Gambler’s Fallacy: Investment is not gambling but day traders & short-term traders love gambling in stocks. In this process, they try to analyse past pattern and forecast future movements purely based on gut feeling and not on the basis of analysis. Avoiding such behavior can give you peace & better return in long run. The problem is if you succeed once, you will feel that it can be repeated again & you will not stop until you give up all your gains. So it is better not to get into this cycle at all.
- Herd Mentality: Most of you must be aware of this. It means following what others are doing. While many investors think they are smart by not buying stocks when market is overpriced but same investors tend to follow famous investors like Jhunjhunwala and other. This is also a type of herd mentality. Do not follow any famous investor blindly since you do not know for what reason they entered the stock & when they will exit. Do your own analysis.
- Anchoring: Again a prevalent bias in which investor try to believe is the first set of information presented to him. He does not analyse if that information is still valid or hold value in present scenario. Sometimes we do not sell a stock since we think it would rise to a certain level and then only selling makes sense. In dynamic environment like stock market, there can not be a fixed fair value of any stock over long period of time and you must update stock’s fair value periodically. Do not hang your anchor at one fixed price.
- Loss Aversion: How many of us check our demat account daily to ensure our portfolio is not going in red. This arises from our fear of loss. A lot of times we know that we should sell bad stocks at a loss from our portfolio but due to loss aversion bias, we continue to hold it without any logical reasons. Many investors may recollect their experience in once famous stocks like Intellect Design Arena or Tree House. Investors should behave like a gardener who prunes bad leaves or branches so that trees can remain healthy & grow.
- FOMO (Fear of missing out): In current scenario where Nifty is touching new high every month, people check which stock is at 52 weeks high or which stock has hit upper circuit today. Looking at these charts makes them fearful of missing out money making opportunities. While these charts can be used as input for further analysis, no stock should be purchased without proper analysis. Most of the times, these upper circuit stocks tend to have lower circuits as well and over a period of time, they don’t go anywhere. Think of Suzlon, stock has been under many circuits but it has not moved decisively in positive direction.
We advise you to go through each bias once again & understand in which area you are more prone. Try to recall some situation where you might have exhibited these biases and repeat in your mind that you will not repeat such biases again. Doing this will ensure that your mind registers and learns from it. If you read this article only once then chances are that you will commit these mistakes again since your mind could not register and learn.
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