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Friday, June 23, 2017

Behavioural biases that affect investment success

An interesting topic came up for discussion during a recent family lunch. Electric vehicles - and how they were going to bring a paradigm shift not only for passenger and goods transportation but also for the oil industry.

The logic went like this: Global warming is being caused by auto emissions. Oil resources are getting depleted. Alternative bio-fuel experiments haven't worked. Electric vehicles are the obvious viable and environment-friendly solution.

Prices of electric cars are high because of lack of volumes. Batteries need to be recharged after travelling fairly short distances. But battery technology is improving. Vehicle prices will fall as demand increases.

A few years back, wind turbine maker Suzlon came out with its IPO. Wind power was touted as the future of energy. Investors piled into the stock and lost their shirts. Why? 

Oil prices came down from well above the $100 mark to $40. Wind power was no longer the talk of the town. It didn't help that Suzlon's technology was faulty.

Aren't these classic cases of judgement influenced by what happened or was heard in the recent past?

Investing success requires a planned and dispassionate approach. Emotions like greed, fear, euphoria, despondency lead to poor decisions. Buying or shorting a huge quantity of stock on 'gut-feel' can lead to disastrous consequences.  

The study of behavioural finance enables us to be aware of some of the common emotional and cognitive biases that affect decision making, like:

1. Anchoring
2. Confirmation
3. Loss aversion
4. Disposition effect
5. Hindsight
6. Familiarity
7. Self attribution
8. Trend chasing

Learn more about these behavioural biases from the following article:
8 Common Biases that impact Investment Decisions

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