Behavioral Finance. Why is it useful in trading?

What is behavioral finance?

For some time now there has been increasing talk about behavioral finance. What is it? What is it for?

Behavioral finance is a branch of economics that along with psychology and social psychology starts from the thesis that people do not behave completely rationally when they invest.

He also believes that markets are not fully efficient.

Behavioral finance, therefore, investigates the patterns of individual and social behaviors in financial markets and how these then influence investors’ choices.

Thegoal of behavioral finance is to identify mistakes that are made in trading and investment choices that are related to irrationality and emotionality.

After highlighting the reasons that lead to falling into such mistakes, behavioral finance helps to change the very behaviors that lead to such fallacious choices that harm trading or lead to investment losses.

Such errors are classified into two categories: EMOTIONAL and COGNITIVE. The former arise from emotions (fear, panic, optimism, euphoria, greed, etc…). The second, cognitive ones (also called cognitive bias) are due to distorted reasoning that leads to nonperforming or fallacious actions. Examples of cognitive biases areloss aversion, misjudgment of information, and overconfidence. Just to name a few of the most important ones.

What is behavioral finance?
What is behavioral finance?

Behavioral finance is increasingly being considered for invnvestments by financial institutions and SICAVs (open-end investment companies). It is no coincidence that as many as three Nobel Laureates in economics in recent years are behavioral.

What is behavioral finance? And how can it help us in investment?

A study of technical analysis and a good knowledge of fundamental analysis are indispensable for a trader who intends to invest his or her money in the market independently and continuously.

However, without control of one’s emotions and knowledge of the cognitive errors that can be made when making choices regarding investments, everything else may be thwarted or otherwise fail to bring the desired results.

Behavioral finance, in this regard, can help us better manage trading. It can make us aware of mistakes that we may make and so it is easier then to avoid them.

As we know, when faced with any novelty, a correct approach to achieving a goal is essential.
Sometimes, when faced with our first financial losses, we are overcome with despondency or the temptation to recover as quickly as possible what we have lost.

Emotionality and erratic cognitive processes take over, leading to rash and incorrect choices most of the time, neglecting technique. Again, a good awareness of behavioral finance theories can save our wallets.

If you are interested in learning more about behavioral finance click here

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