More and more financial professionals are embracing psychology in a bid to improve their profit turnover, cut their losses, and reduce the impact that their emotions have on the investments that they make.
They are doing so because cultivating a deeper understanding of the human psyche allows them to understand why they make certain investments. With this knowledge at hand, they can then spot the deficiencies in their decision-making process and ultimately make more sound and well-informed decisions going forward.
If you are an investor or an accounting professional and want to improve your gains, then you should be sure to explore the impact psychology has on the financial sector. This exploration should start with the information laid out below.
Behavioural biases occur whenever the brain takes a mental shortcut. They are highly systematic due to the fact that they cut out the need for overthinking, but they do lack the statistical structure of a more informed approach. In many ways, they are an instant, uncontrollable reaction to certain events, and these can make financial professionals like yourself implement snap decisions based on gut instinct.
These subconscious thought patterns play a major role in many areas of the financial sector, not least in the field of trading. The following six biases play an especially important role in trading and influence traders across the globe each and every day:
- Availability bias. The tendency to make decisions based on data that is readily accessible.
- Anchoring bias. The proclivity of allowing an initial piece of information to have a somewhat disproportionate impact on decisions going forward.
- Hindsight bias. The belief that an individual was in control of the situation once the end result was made clear to them, often leading to a false sense of confidence in their abilities.
- Confirmation bias. The tendency to value certain pieces of information because they align with one’s own beliefs.
- Loss aversion bias. The preference to avoid certain markets because their chances of being a ‘bear’ are too great.
- Gambler’s fallacy. The tendency to believe that past events have an impact on future investments, despite there being no substantive evidence to support the affirmation.
Similar to the loss aversion bias, prospect theory details how financial professionals view both gains and losses. If this theory is to be believed, investors will always value potential gains rather than prospective losses, simply because that’s the way the human psyche is wired.
Of course, this specific type of bias can prove itself to be incredibly profitable in certain instances, as it can wield great financial success. Other times, however, it can lead to significant, un-informed risks being taken by investors and, subsequently, result in them suffering serious losses.
If you’re to succeed in the field of trading, it’s important that you know of respect theory’s existence. Simply knowing that you are prone to valuing gain over loss will allow you to keep your impulsivity in check. Instead of going full steam ahead with an investment based on the money that you stand to earn, take a step back and consider all of the things that you stand to lose by taking certain risks.
Helen Bradfield did her degree in psychology at the University of Edinburgh. She has an ongoing interest in mental health and well-being.