Investment
Psychological traps in a market crisis
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In finance textbooks, academics assume that investors act rationally when making investment decisions. However, in practice, investors are not fully rational. This is especially true during market crises such as the severe volatility and uncertainty brought on by the coronavirus (COVID-19) pandemic. At times of distress and uncertainty, investors are subject to psychological biases when making investment decisions.

Regardless of how disciplined they are, people invest with innate behavioural biases that cause them to act on emotion rather than based on facts. This is the basis of behavioural finance, a field of study that combines psychological theory with conventional eco- nomics. This paper discusses several psychological traps that inves- tors should avoid during a market crisis.

1. Overconfidence

Studies show that overconfident investors trade more frequently and fail to appropriately diversify their portfolio. To counter an overcon- fident mindset, investors should consider trading less and invest- ing more. By entering into trading activities, investors are trading against computers, institutional investors, fund managers and others around the world who can have far better data and more experience.

By increasing their timeframe and holding a diversified portfolio with exposures to different asset classes that are uncorrelated, in- vestors are more likely to consistently build wealth over time. They would be well advised to resist the urge to believe that their information and intuition is better than others in the market. Overconfidence leads to the unfounded belief that the investor possesses superior stock-picking abilities when they in fact do not.

2. Confirmation bias

Confirmation bias suggests that an investor would be more likely to look for information that supports their original idea about an invest- ment rather than seek out information that contradicts it.

As a result, this bias can often result in irrational de- cision-making because one-sided information tends to skew an investor's frame of reference, leaving them with an incomplete picture of the situation.

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