Behavioural finance makes use of financial psychology to understand and study the actions of investors.
According to behavioural finance, investors don’t act rationally but with cognitive biases and limited self-control. Decisions based on emotions often cause errors in their judgement.
Let’s take a look at the 5 main concepts of behavioural finance.
This refers to the common practice wherein people allocate money for different purposes or goals.
This refers to the act of decision-making based on emotions as opposed to making rational and thought-out decisions.
This is the practice of basing investment decisions on
pre-existing information.
An example of anchoring would be holding on to a loss-making stock to avoid selling it at a lesser price than the one it was bought at.
This is the practice of making decisions based on one’s own knowledge. People generally overestimate their skills and end up making flawed decisions.
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