4 psychological biases that influence investor decision-making

The year 2015 has been very turbulent for investors and their nerves are being sorely tested right now. It is in such circumstances that the do-it-yourself investor can make poor investment decisions. Research in behavioral finance have defined a number of cognitive or psychological biases that can influence a stock investor's decision-making.

Here are four that can help you gain perspective on how you manage your stock portfolio.

Overconfidence

L'overconfidence This is what leads us to overestimate our investment capabilities.

This excessive confidence can ultimately be a major source of disappointment. On the stock market, many investors think they have found the new "gem" of the moment.

The reality is that this is rarely the case. Studies show thatoverconfidence leads overconfident investors to buy and sell more quickly than others: they are convinced that they know more than their peers.

Never forget that transaction costs have an unfortunate tendency to heavily penalize yields.

Conversely, Benjamin Graham Or Warren Buffett have demonstrated that by taking into account a margin of safety, to protect against the inability to predict the future accurately, it is possible to better control the risk of a stock market investment.

Risk aversion

We have all seen it: if the majority of the lines in your portfolio are in the green, you will only remember the minority that are in the red and losing money.

This behavior is called risk aversion. Investors find it easier to sell stocks that are making money than to liquidate stocks that are losing money.

Regret can also play a role in risk aversion. We regret bad results, for example when a stock lines up the phases of decline on the Stock Market while the fundamentals of it remain excellent, the regret felt then, can lead to selling it rather than showing patience or even strengthening our position.

The sunk cost

Our failure to ignore the sunk cost of a disappointing investment can lead us to misjudge certain situations based solely on their own merits.

Because investors do not know what the sunk cost of a stock is, they tend to hold on to a stock that is losing money even as the underlying business of that stock deteriorates.

Yet, if this stock had been given away rather than purchased, the investor would probably have sold it long ago.

Herd behavior

There are hundreds of stocks available in the markets. Investors cannot have a high level of knowledge about all of them. In fact, it is very difficult to have a high level of knowledge about even a limited number of stocks.

The constant bombardment of investment ideas from the media, brokers, magazines and websites means that investors ultimately trade securities based on the many recommendations that emerge from these countless sources, which are not always very credible.

Unfortunately, in the majority of cases, the stocks that attract so much attention do so because they have had an excellent track record in the stock market, not because their current valuations and fundamentals dictate an attractive buying opportunity.

Deciding whether to buy a security in such circumstances is a matter of sheep-like behavior and is very likely to make you buy a stock that is certainly popular, but extremely overvalued.

This does not mean that investors should not be attentive to their environment. But their portfolio management should be based on factual and fundamental data, rather than on the movements of the stock market and other investors.