I have copied and pasted from CFA Institute's website an article on investment bias (https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/behavioral-biases-individuals).Due to the mass of verbiage, I have highlighted some key words and reformatted the paragraphs to make the article more eye-friendly.
A good read and useful for self-checking. Also a helpful tool for posters to assess any information given by others.
Behavioral biases potentially affect the behaviors and decisions of financial market participants.Individuals do not necessarily act rationally and consider all available information in the decision-making process because they may be influenced by behavioral biases. Biases may lead to suboptimal decisions.
By understanding these biases, financial market participants may be able to moderate or adapt to them and, as a result, improve upon economic outcomes. Behavioral biases may be categorized as either
cognitive errors or
emotional biases. The type of bias influences whether its impact may be
moderated or
adapted.
- To moderate a bias is to recognize the bias and to attempt to reduce or even eliminate the bias within the individual.
- To adapt to a bias is to recognize and accept the bias and to adjust for the bias rather than to attempt to moderate the bias.
Behavioral biases may be categorized as either cognitive errors or emotional biases.
A single bias may have aspects of both, however, with one type of bias dominating.Cognitive errors stem from basic statistical, information-processing, or memory errors; cognitive errors typically result from faulty reasoning.- Cognitive errors are more easily corrected for because they stem from faulty reasoning rather than an emotional predisposition.
Cognitive errors can be further classified into two categories: belief perseverance biases and information-processing biases.Belief perseverance biases- Belief perseverance errors reflect an inclination to maintain beliefs. The belief is maintained by committing statistical, information-processing, or memory errors.
- Belief perseverance biases are closely related to the psychological concept of cognitive dissonance. Belief perseverance biases include conservatism, confirmation, representativeness, illusion of control, and hindsight.
Information-processing biases- Information-processing biases result in information being processed and used illogically or irrationally.
- Information-processing biases include anchoring and adjustment, mental accounting, framing, and availability.
Emotional biases stem from impulse or intuition and tend to result from reasoning influenced by feelings.- Emotional biases are harder to correct for because they are based on feelings, which can be difficult to change.
- Emotional biases include loss aversion, overconfidence, self-control, status quo, endowment, and regret aversion.
Understanding and detecting biases is the first step in overcoming the effect of biases on financial decisions. By understanding behavioral biases, financial market participants may be able to moderate or adapt to the biases and, as a result, improve upon economic outcomes.
Behavioral finance has the potential to explain some apparent deviations from market efficiency (market anomalies).
End.
(20min delay)