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Investing PI 1

Investing PI 1 - Smith won the 2002 Nobel Prize in...

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The goal is to buy low and sell high but we tend to buy high and sell low, whether that be in small bull rallies or a huge one that began in spring of 2009. By following the models that professionals make, which are often wrong, the professionals and the individual investor tend to do the wrong things at the same time. Long Term Capital Management was forced by the Federal Reserve bank to be sold to other investnment and commercial bank because they would not accept they had made a mistake and continued to gamble more and more on what was making them lose money. In traditional finance, they believe that humans make rational decisions and they are unbiased in the predictions about the future. People do not act accordingly because they will seek risk aversion unless the reward is sufficient yet they will buy insurance and lottery tickets at the same time. Psychologist Daniel Kahneman and experimental economist Vernon
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Unformatted text preview: Smith won the 2002 Nobel Prize in Economics for vindicating why pshchology affects investing. Behavioral finance contributions include (1) documenting actual investor behaviro; (2) documenting price patterns that seem inconsistent with traditional models with rational investors; and (3) providing new theories to explain these behaviors and patterns. Our brain makes shortcuts to process all the information we see, also known as psychological biases. A common problem is overestimating the precision and importance of information. Anchoring is where people hook onto a specific number in trying to make a decision. Traditional finance has brought us arbitrage theory, portfolio theory, asses pricing theory, and option pricing theory with the basis that people are rational. People are affected by the gambler's fallacy, a part of a larger misunderstanding referred to as the law of small numbers....
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