Behavioural finance

I have no doubt that psychology plays a huge part in determining market prices. Fear and greed drive prices away from their intrinsic values. However, while it is interesting to understand how investors behave in different circumstances and why they behave that way, behavioural finance cannot be used directly to make money. Nevertheless, an understanding of behavioural finance helps to avoid some irrational decisions. Some of the findings of behavioural finance are:

1. Investors under-react to new information. Their prejudices prevent them from changing their minds quickly. That contributes to a delay between new information becoming available and the price adjusting to the full extent.
2. Growth shares are more susceptible to fear and greed than value shares.
3. General moods of pessimism and optimism as in bear and bull markets cause prices to be under or over their intrinsic values.
4. Investors generally are not comfortable behaving differently from the majority.
5. Investors tend to rationalise chance events and assume that these could have been predicted with foresight.
6. Investors use simple rules that may have worked in the past but do not recognise when conditions have changed that make these rules invalid.
7. Investors tend to extrapolate from historical data and assume that the trend will continue.
8. Investors are influenced by whatever they paid for the share and are reluctant to take losses though the conditions may have changed.
9. Investors sometimes gather a lot of irrelevant information and then get the mistaken belief that they have researched the company thoroughly. They are unable to discern the crucial bits that will drive the price.
10. Investors tend to sell winners too quickly to hasten the feeling of pride at having bought a winner and sell losers too slowly to avoid as long as possible the feeling of regret at having bought a loser..
11. Investors focus on the available information and do not think sufficiently about the risks of not considering the unavailable information.
12. Investors tend to overweight recent information and underweight long-term tendencies.