Behavioral Science of Investments

Psychology of Investing

"I can calculate the motions of heavenly bodies... But not the madness of people!"
Isaac Newton (1642 - 1727)

People have been acting the same for hundreds of years. Not much has changed since Isaac Newton lost a fortune in the South Sea Trading Company's fiasco of 1720. This trading company had all the characteristics of a contemporary "hot stock," with investors creating a mania over the company's prospects for success.

Investors' dreams that the company would gain trade monopolies in the South Seas sent the company's price into the stratosphere! And, as we've seen in the more recent past, the story ended the way it had to... Badly! The majority of the investors were wiped out!

Much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process.

However, researchers have uncovered a surprisingly large amount of evidence that this is frequently not the case!

Dozens of examples of irrational behavior and repeated errors in judgement have been documented in academic studies. Peter Leonard Bernstein in his 1996 book "Against The Gods" states that the evidence "reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty."

A field known as "behavioral finance" has evolved that attempts to better understand and explain how emotions and cognitive errors influence investors and the decision-making process. Many researchers believe that the study of psychology and other social sciences can shed considerable light on the efficiency of financial markets as well as explain many stock market anomalies, market bubbles, and crashes.

Investing can be an emotional process unless you understand what you are investing in, what you're trying to accomplish and understand a few basic facts and statistics!

To make educated decisions and to avoid the emotional ones always try to pursue the rational and logical side of investing.

Remember, facts and statistics are the basis for good and profitable investing. The stock market is not gambling! Gambling is never included in companies' annual reports!

Reprinted with permission of  I.E.C. Haramis of http://www.greekshares.com and http://www.investlearn.com These are two good sites worth visiting.