Psychology of Investing

Psychology of Investing - Psychology of Investing.Study...

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Psychology of Investing .Study Guide. Chapter 2: Overconfidence Overconfident investors: o Trade too much (frequency and amount) o Trade too much risk o Earn lower profits Lower returns result from commission costs associated with high levels of trading and the propensity to purchase stocks that underperform the stocks that were sold Illusion of Knowledge – tendency of people to think that the accuracy of their forecasts increases with more information – ex. Internet. Not always true Illusion of Control – people often believe they have influence over the outcome of uncontrollable events. Key attributes: o Choice – making an active choice induces control o Outcome Sequence – early positive outcomes give the person a greater illusion of control than early negative outcomes do o Task Familiarity – the more familiar people are with a certain task, the more they feel in control of the task o Information – when a greater amount of information is obtained, the illusion of control is greater o Active Involvement – when a person participates a great deal in a task, the feeling of being in control is also proportionately greater o Past Successes – If a decision turns out to be good, it is attributed to skill and ability (overconfidence). If a decision turns out to be bad, then it is attributed to bad luck. Online trading increases overconfidence Chapter 3: Pride and Regret Disposition Effect - People avoid actions that create regret and seek actions that cause pride. This causes people to sell winners too early and ride losers for too long. o Problem because when you sell a winner, you must pay taxes on the realized gain, which reduces profit. o Selling winners too soon means that the stock will continue to get better after you sell it. Holding on to losers for too long means that your position will probably get worse. Reference Points – the stock price that we compare with the current stock price. There is no set point – the brain chooses, which determines whether we feel the pleasure of obtaining a profit or pain of a loss. Chapter 4: Considering the Past House-Money Effect – after people experience a gain or a profit, they are willing to take more risk because it doesn’t feel like their own money.
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This note was uploaded on 02/19/2012 for the course BIP 364 taught by Professor Stephenlevin during the Fall '10 term at Northwestern.

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Psychology of Investing - Psychology of Investing.Study...

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