The phrase ‘Lame Duck’ has, for the longest time, been used amongst traders to describe those whose positions in capital instruments always results in huge capital losses. Sometimes, even driving some to a point of bankruptcy. Almost all of us, at some point, have had a lame duck experience, or something close to it. Interesting thing is that, until assets held start taking a hit, one is normally convinced they have everything figured out about an investment. But studies over the years on the subject of behavioural finance have shown that most investing decisions made on the premise of being rational are actually bias driven. The biases they came up with give us a glimpse of what inspires some of our investing decisions.
Here are a couple of them outlined ;
Gamblers fallacy
Professional traders in the stock market use advanced analysis tools, whether technical or fundamental to monitor stocks they are interested in through their random walk on the stock market . The main idea always being to find viable exit and entry positions by using various trading strategies at their disposal to avert losses.
On the other hand, a gambler’s entry and exits from a position is mainly based on the idea that a stock’s price upward or downward movement is an onset determined by it’s previous price, although random events rarely predict the outcome of other random events. This means they get to liquidate positions at the wrong time.
Prospect theory
In investing, both losses and gains are to be expected. Occasionally, some investments make losses over prolonged periods before returning any gains to the investors. However to most investors this would not be an investment they’d pick when presented with another investment that promises gains over the same period. Even if minimal. This line of thought is summarized in the prospect theory,advanced by Daniel kahneman, that observes investors are reserved towards loss making investments with a probability of future gains and are more open towards those that promise gains. Also called the loss aversion theory.
Confirmation Bias
In recent times, our markets have seen rapid developments that can be attributed to technological advances and slight integration into the global financial system. Even though the efficiency of the markets has been improved, the problem of asymmetric information remains a big challenge. It opens the market to unethical professionals who peddle wrong information especially to those driven by the confirmation bias. The bias observes that investors are more likely to seek information that supports their thoughts on an investment rather than those that contradicts it.This crowds any form of rationality when picking investments since any contradicting thought is shunned.
Mental Accounting
In mental accounting, Richard Thaler observed that Investors tend to assign money to different asset classes depending on the specific utility it has been dedicated to depending on the risk that comes with owning those assets. This means at any one given time the investor will have assets they consider to be ‘safe’ and others that they classify as being risky or with unpredictable returns. Thus the assets are held separately. The main disadvantage of mental accounting is that it leads to major loses in the end because it gives the investor free will to put money in highly risky investments which are likely to make huge losses eventually that cancel out the gains that are to be made from the ‘safe’ investments.
The main idea behind the biases is to try to understand the decisions made by investors and most importantly help them understand why they make certain investment decisions even when they seem to be irrational. Simply put,when you go out to invest in any market,evaluate yourself and know what kind of an investor you are.