What are behavioural biases?
Behavioural biases are irrational beliefs or behaviours that can unconsciously influence our decision-making.
Some of the most common biases that investors possess are:
Anchoring bias: This is a bias where changes are made but in relation to the initial view, and therefore the changes are inadequate. New information is not analyzed individually but as an adjustment to the initial view.
Confirmation bias: This occurs when investors look for new information or distort further information to support an existing view. For instance, ITC is viewed as a tobacco company despite growing the FMCG segment!
Loss-aversion bias: This is a bias where investors feel more pain from a loss than pleasure from an equal gain. The displeasure from a ₹10k loss is way more than the pleasure from a similar gain!
How do these affect stock market investors?
Anchoring bias: Here, investors stay anchored to an initial estimate and do not adjust for new information.
Confirmation bias: Here, investors may consider favourable but ignore negative information and therefore hold investments too long.
Loss-aversion bias: This bias implies that investors tend to hold onto losing stocks too long but may sell winners quickly. Also, trading too much by selling for small gains raises transaction costs and lowers returns.
How can investors overcome them?
Anchoring bias: Investors can start by asking, “Am I staying with this stock because I originally recommended it at a higher price? Am I becoming dependent on that previous price?”
Confirmation bias: Investors can overcome confirmation bias by seeking/asking for contrary views or information. All information, whether positive or negative, needs to be considered.
Loss-aversion bias: This bias can be overcome by maintaining a disciplined, well-thought process based on an investment’s prospects, not perceived gain or loss.
Investing is more of an art rather than a science. What may seem obvious to you might be considered foolish by your neighbour. And that is why knowing and acknowledging your behavioural biases is desirable!