Behavioral finance

Behavioral finance is the study of the influence of psychology on the behaviorr of investors and the effect this has on markets.

Investors behave unexpectedly and irrationally in systematic and predictable ways. According to behavioral finance, markets are not always efficient. It is human behavior that moves markets and not universal information shared by market participants.

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Behavioral finance focuses on human emotional biases causing markets to display initial under reaction followed by delayed overreaction.

Behavioral Finance Theory

Behavioral Finance

Anchoring and confirmation bias keep prices from reflecting their true values. The disposition effect impedes asset’s rise to true value due to premature selling and to buying inertia.

In the long term, there is a catch process that leads to overreaction through herding behavior and the bandwagon effect. All of these effects lead to creating momentum inducing behavior.

Biases include anchoring, confirmation bias, herding, conservatism bias, representativeness bias, overconfidence and disposition effect.