\u201cA reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth. Authoritarian institutions and marketers have always known this fact.\u201d \u2014Daniel Kahneman, \u201cThinking Fast and Slow\u201d<\/p>\n
Daniel Kahneman began his Nobel Prize-winning research in the late 1960s. He drew on cognitive psychology to understand how people made decisions under uncertainty. His research resulted in the formulation of a new branch of economics\u2014prospect theory and loss aversion\u2014the concept that we perceive losses always being greater than gains of the same size.<\/p>\n
Early on, Kahneman and his longtime research partner, Amos Tversky, concluded that most economic theories held the mistaken notion that humans act rationally when making economic choices. The pair offered a counterargument to the assumptions of traditional economics, based on exposing people\u2019s hard-wired mental biases that tend to distort their judgment, leading to incorrect conclusions and lead to unanticipated results.<\/p>\n
These identifiable biases distort investors\u2019 perception of information and may cause them to reach erroneous conclusions, even if their information is correct.<\/p>\n
It\u2019s common for investors to stray from what is logical, even what is rational, when evaluating financial information. Emotions, biases and even personality traits can all get in the way of clear thinking. Despite the common belief that investing is primarily analyzing data to make decisions, emotions and behaviors play a major role in determining whether those decisions prove successful.<\/p>\n
Tversky and Kahneman\u2019s pioneering work in addressing why people cling to certain beliefs led them to conclude that \u201cpeople rely on a limited number of heuristic (empirical) principles which reduce the complex task of assessing probabilities and predicting values to simpler judgmental operations, and this can lead to severe and systemic errors.\u201d<\/p>\n
When behavioral finance expert Daniel Kahneman was asked what could be done to overcome behavioral biases, he remarked, \u201cVery little; I have 40 years of experience with this, and I still commit these errors.\u201d While Behavioral Finance identifies dozens of cognitive biases that cause individuals to make poor investment decisions, one of the more common behavioral errors Kahneman identified is the tendency to overreact to market volatility and make kneejerk judgments under stressful conditions, typically when the markets are roiling.<\/p>\n
Most investors have an inverted perception of supply and demand economics. As the market goes up, there’s more demand and more investors participating. When markets go down, there’s less. Yet, in almost every other economic environment, when something goes on sale, that is, when the price goes down, there\u2019s more demand and more people participating.<\/p>\n
If, from a fundamental perspective, you believe in an asset at a specific price and that price goes down, you would logically buy more of it. The way trends work in the financial markets, however, is that price reductions cause people to sell out, mainly out of fear. It\u2019s completely counterintuitive thinking, but upside-down human behavior is what drives the market and creates trends.<\/p>\n
When the economic atmosphere experiences turbulence, like an inexperienced pilot, investors lose their nerve, become disoriented and end up crashing their portfolio. When the markets plunge, they lack the confidence to take enough risk. When a bull market emerges, they pivot and take too much risk. On the other hand, when the proper asset allocation and investment decisions for each market environment have been predetermined under objective, dispassionate conditions, investors gain the courage to ignore the noise all around them.<\/p>\n
Sources:
\nRobert Hersey Jr, \u201cDaniel Kahneman, Who Plumbed the Psychology of Economics,
\nDies at 90,\u201d The New York Times, 27 Mar 2024.
\nAmos Tversky and Daniel Kahneman, \u201cJudgment under Uncertainty: Hueristics and
\nBiases,\u201d Science 27 Sept 1974 pp1124-1131.
\nhttps:\/\/thedecisionlab.com\/thinkers\/economics\/daniel-kahneman<\/p>\n
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\u201cA reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth. Authoritarian institutions and marketers have always known this fact.\u201d \u2014Daniel Kahneman, \u201cThinking Fast and Slow\u201d Daniel Kahneman began his Nobel Prize-winning research in the late 1960s. He drew on cognitive psychology to understand how people […]<\/p>\n","protected":false},"author":6,"featured_media":21786,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[1],"tags":[],"class_list":["post-21784","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorized"],"yoast_head":"\n