Behavioural Finance

Topics: Finance, Investment, Bias Pages: 8 (2936 words) Published: April 2, 2013

INVESTMENT MADNESS How Psychology Affects Your Investing…and What to Do About It JOHN R. NOFSINGER



John R. Nofsinger. Investment Madness-How Psychology Affects Your investing….and what to do about it. p. cm.—(Financial Times Prentice Hall books)

The book I chose to review for this assignment is entitled, “Investment Madness-How Psychology Affects Your investing….and what to do about it” by the author John. R. Nofsinger. In this book the author has described that how our own psychological biases can creep into our investment decisions. The Author divided this book into five sections: 1) First part shows that how few biases like Overconfidence or Status Quo etc. affects investors thinking. Investors are not able to think clearly due to these biases. 2) In this section, author describes the biases related to investors emotions like Seeking Pride or Avoiding Regret or Double or Nothing etc., it also shows that how investors decisions are affected by there emotions.

3) In this section, author describes the biases related to investors brain like Mental Accounting Bias, Representativeness, Cognitive Dissonance etc., it also shows that how our mind affects our decisions while investing. 4) Fourth section describes that how internet helps in increasing the number of investors, how the psychology of an investor suggests him to invest through internet.

5) In this section author describes that what one can do to avoid these kind of situations: A. One can avoid through Self Control B. By battling various biases by following strategies: Strategy 1: Understand Your Psychological Biases Strategy 2: Know Why You Are Investing Strategy 3: Have Quantitative Investment Criteria Strategy 4: Diversify Strategy 5: Control Your Investing Environment

The author starts the book with a deep thought that Should I read this book now or later, answer to this is given later by most of the peoples. According to Nofsinger, the field of finance has evolved on two basic assumptions: People make rational decisions. People are unbiased in their predictions about the future. He further states that behavioral finance studies how people actually behave in a financial setting. Actually Behavioural Finance is the study of how psychology affects financial decisions, corporations, and the financial markets. Nofsinger describes with an figure in which roller coaster represents the modern investment environment, this is like our stock market, which has dramatic highs and lows. We go from a high to a low and back again these days at what seems like frightening speeds. Then Author Continues with Overconfident Bias, psychologists have found that people become overconfident when they experience early success in a new activity. Availability of more information and a higher degree of control leads to higher overconfidence. These factors are referred to as the illusion of knowledge and the illusion of control. According to illusion of knowledge, with the increase in the information, the accuracy of peoples forecasting also increases, for describing this Author used the example of Six Sided Dice. Book continues with the Illusion of Control which says that when peoplefeel like they have control of the outcome, they become even more overconfident, even when it is clearly not the case. Following are the key attributes that foster the illusion of control: Choice: The choice attribute refers to the mistaken feeling that an active choice induces control. Outcome Sequence: Positive outcomes that occur early give the person a greater illusion of control than early negative outcomes. Even something as simple and transparent as being right on the first two tosses of a coin can lead to an increased feeling of having the ability to predict the next toss.

Task Familiarity: The more familiar people are with a task,...
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