Behavioral Finance

Traditional finance assumes people make rational decisions based on all available information. Behavioral finance recognises that real people often behave differently, in ways that can be predicted and studied.

Common behavioural biases include loss aversion, feeling losses more strongly than equivalent gains; overconfidence, overestimating one's own knowledge or skill; herding, following what others are doing; anchoring, relying too heavily on an initial piece of information, such as the price paid for a share; confirmation bias, seeking information that supports existing beliefs; and recency bias, giving too much weight to recent events.

For example, an investor may refuse to sell a falling share because they do not want to admit a loss, while quickly selling a rising share to lock in a gain, a pattern called the disposition effect.

Behavioral finance helps explain market phenomena that traditional theory struggles with, such as bubbles, crashes and periods of extreme optimism or pessimism.

Understanding these biases can help investors make better decisions, for example by setting clear rules in advance, automating regular investments and avoiding reactions to short-term news. The field gained wide recognition through the work of psychologists Daniel Kahneman and Amos Tversky and economist Richard Thaler.