What Is Behavioral Finance?
Behavioural finance is the study of the influence of psychology of investors and traders. Moreover, influences and biases can be the source for explanation of all types of market abnormalities in the stock market, such as sharp rises or falls in stock price as experienced recently in the cannabis sector in the recent years. Some cannabis stocks are near 99% off from 52 week highs and some are close to 52 week highs, see cannabis stock price data HERE.
Understanding Behavioural Finance (Investopedia)
Behavioural finance can be analyzed from a variety of perspectives. Stock market returns are one area of finance where psychological behaviours are often assumed to influence market outcomes and returns but there are also many different angles for observation. The purpose for classification of behavioural finance is to help understand why people make certain financial choices and how those choices can affect markets. Within behavioural finance, it is assumed that financial participants are not perfectly rational and self-controlled but rather psychologically influential with somewhat normal and self-controlling tendencies.
One of the key aspects of behavioural finance studies is the influence of biases.
Biases Studied in Behavioral Finance
Breaking down biases further specifically for cannabis investors and traders, many individual biases and tendencies have been identified for behavioral finance analysis, including:
Disposition bias refers to when investors sell their winners and hang onto their losers. Investors’ thinking is that they want to realize gains quickly. However, when an investment is losing money, they’ll hold onto it because they want to get back to even or their initial price. Investors tend to admit their correct about an investment quickly (when there’s a gain). However, investors are reluctant to admit when they made an investment mistake (when there’s a loss). The flaw in disposition bias is that the performance of the investment is often tied to the entry price for the investor. In other words, investors gauge the performance of their investment based on their individual entry price disregarding fundamentals or attributes of the investment that may have changed.
Confirmation bias is when investors have a bias to accepting information that confirms their already-held belief in an investment. If information surfaces, investors accept it readily to confirm that they’re correct about their investment decision—even if the information is flawed.
An experiential bias occurs when investors’ memory of recent events makes them biased or leads them to believe that the event is far more likely to occur again. For example, the financial crisis in 2008 and 2009 led many investors to exit the stock market. Many had a dismal view of the markets and likely expected more economic hardship in the coming years. The experience of having gone through such a negative event increased their bias or likelihood that the event could reoccur. In reality, the economy recovered, and the market bounced back in the years to follow.
Loss aversion occurs when investors place a greater weighting on the concern for losses than the pleasure from market gains. In other words, they’re far more likely to try to assign a higher priority on avoiding losses than making investment gains. As a result, some investors might want a higher payout to compensate for losses. If the high payout isn’t likely, they might try to avoid losses altogether even if the investment’s risk is acceptable from a rational standpoint.
Ontario Securities Commission Survey Results
In October 2018, the Ontario Securities Commission (OSC) Investor Office commissioned a survey of over 2,000 Canadians from across the country that sheds light on how retail investors have reacted to recent developments in the cannabis sector.
Several factors give rise to concern about the risks
retail investors are taking in this emerging sector:
Nearly 1 in 4 cannabis investors reported spending $10,000 or more on their investments.
Those with low financial knowledge or who reported having a low risk tolerance were as likely as individuals with higher knowledge or risk tolerance to own cannabis investments.
What drives people to buy into trendy cannabis investments?
Behavioural insights show that some investors may be predisposed to seek out and buy into the latest, most popular investments—and may do so even if these investments don’t fit their long-term financial goals. These investors may overestimate their risk tolerance and might not diversify their investments enough.
Our survey results indicate that many cannabis investors entered the sector recently, and that word of mouth was a key source of information. Aurora Cannabis is the perfect example of a momentum stock for the social media era. (Click HERE for Latest Aurora Cannabis Updates on Global Operation and Growth Initiatives)
Behavioral Finance in the Stock Market
The understanding and usage of behavioural finance biases is applied to stock and other trading market movements on a daily basis. Broadly, behavioural finance theories have also been used to provide clearer explanations of substantial market anomalies like bubbles and deep recessions. These trends can be used to help analyze market price levels and fluctuations for speculation as well as decision-making purposes.
Chasing trends can be exciting, but it is also important
to make a long-term plan and stick to it.
Disclaimer: All posts made on this website are provided for information purposes only. None of the information here is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, Company, or fund. Before making an investment decision, you should seek the advice of a qualified and registered securities professional. The author is not paid to share this information and may or may not own shares in the company.