Let's talk about behavioral finance today, it is a combination of psychology with traditional finance, and it is important to guide us toward making the right decisions in terms of investment.
Traditional finance is dependent on the assumption that humans are rational, self-interested beings who are capable of making unbiased decisions. Behavioral finance builds greatly on biases and emotions, but other factors play a significant role in the place of making decisions that would make one drift away from traditional finance principles.
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An investor must understand the importance of behavioral finance, this is highly crucial for investment decisions to be made. An investor needs to also understand that deviations from the principles of traditional finances can have a great impact on the outcomes of investments.
Behavioral finance is strategically aimed at being able to identify and understand the existing deviations from traditional finance and then help to develop strategies for mitigating their impacts. Behavioral finance also deals greatly with, understanding how these deviations impact the market on an overall level.
As a trader, you need to understand why you do the things you do, and take advantage of the emotional factors that influence the decisions you make daily financially, here are a few important reasons;
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Limited risk: When the place of emotions and biases is acknowledged in the investment decisions made, it is possible to reduce the risk of impulsive or emotional decisions that may lead to a negative outcome financially, with this mindset, it is also easier to snap out of greed and fear very conveniently.
Decision-making is improved: You can understand how emotions and biases influence decisions that are based on investment, and how they can help you make more informed and objective decisions. When you recognize your own biases, it becomes easy for you to work to counteract their impact and make investment decisions that are based on financial data as well as your long-term goals.
Alignment with financial goals: With a clear emotional understanding, it becomes better for you to align your investment decisions with long-term financial goals instead of being swayed away by only short-term emotions.
A good investor knows how well to balance traditional finance with behavioral finance to achieve a more adequate financial analysis and by extension, a better result.
Traditional finance assumes rational decision-making, while behavioral finance acknowledges the influence of emotions and biases.
Traditional finance focuses on financial data and economic models while behavioral finance considers significant psychological factors and how decision-making may be greatly impacted.
Traditional finance emphasizes the importance of maximizing financial returns while behavioral finance recognizes that investors may need to prioritize non-financial goals and emotions.
Traditional finance ignores the place of emotions and biases when it comes to decision-making making while behavioral finance focuses on how emotions and biases can impact investment decisions.
Traditional finance views the investor as a passive participant in the market while behavioral investor not only sees the investor as an active participant but one who can make decisions based on emotions and biases.
In conclusion, traditional finance assumes that investors make perfectly rational decisions, and behavioral finance acknowledges that emotions and biases are unable to play a role in investment decisions.