A behavioral bias can be defined as the short mental path that human beings use to carry out the decision-making process in a simpler way. However, this can cause us to make decisions without applying rational thinking.
That is, a behavioral bias can be considered as a trend in behavior that makes us make unreasonable decisions. Especially when we are faced with stimuli or information that is threatening or negative. Impelling us to follow certain subjective and unreasonable mental schemes.
In effect, this leads us to give partial and unreasonable answers. Therefore, this is a matter of concern in the field of finance, especially when people have to make investment decisions.
Undoubtedly, what is pursued is that behavioral biases are better known and understood. Since, thus, people can be more precise and rational in their decision-making process. Above all, when making investment decisions and thus obtain better results.
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Types of behavioral biases
Among the main behavioral biases, we can mention:
- Overconfidence: It is the bias that makes the person come to make decisions about what they know. Considering himself an expert on the subject, which leads him to assume a higher level of risk. People come to believe that they know more than they really do.
- Follow the pack: In this bias, the investor makes decisions by imitating the decisions made by investors who obtain the highest profits. They follow the movements of market experts.
- Illusion of being in control: This occurs when the subject thinks that they have total control of the situation. Although, in reality it is not. What can lead to failure by making bad decisions.
- Opposite strategy: In this case, the investor buys assets and actions that present a negative behavior. Hoping to sell them when they get a higher price and benefit from that decision.
- layout effect: It occurs when the investor markets the best assets in a very short time. Keeping the bad assets for a very long time. This decision leads to lousy results and bad business.
- Overreaction: It occurs when the investor gives more importance to the information of the current behavior of the market. Giving little relevance to historical data to make the decision. Making hasty decisions.
- Overreaction: On the contrary, the investor does not respond to the relevant changes that are taking place in the market. Which leads to dismissing important market information in their decision-making process.
- Optimism: The investor perceives huge profits in advance. So he overreacts by investing in huge amounts, wanting to make huge profits.
- Pessimism: Conversely, the pessimistic bias leads the investor to invest very little or not at all. That before the perception of little benefit or even for the fear of loss.
- Strategy of the moment: It consists of considering the trends and short-term behavior of the market. But, leaving aside the effect on the long term. Causing that all the necessary variables are not considered in the decision.
Why is it important to understand behavioral biases?
To begin with, we can state that it is essential to understand and understand behavioral biases. Because, a bias can lead us to have a wrong interpretation of the information we handle. Leading us to make judgments and decisions in the wrong way.
Furthermore, a behavioral bias can be considered as a bad mental habit. That leads us to stop making decisions rationally. But, if we have adequate knowledge of how they work and how they are presented, we can prevent them from negatively influencing our decision-making process. We could even use them for our own benefit.
In conclusion, it can be determined that biases are always present in human behavior. But if we know them and how they work, we can minimize their impact on the decision-making process. Achieving the best results, especially when making investment decisions.