Behavioural biases in equity investing and ways to manage them as an investor

Behavioural biases in equity investing and ways to manage them as an investor

1) What is anchoring bias and how can it be managed by an investor? 

The anchoring bias involves an equity investor becoming fixated on where the price of the share is trading vis-a-vis the 52-week low/high for the stock. The investor may choose to buy when the stock price is trading near its 52-week low compared to a 52-week high on the assumption that the price is low. However, the reason that the company is trading at a 52-week low may be the one to avoid investing in the company as the fundamentals of the company are poor. As an investor, one should focus on the financial performance of a company while investing and not be too worried about the price level of the share. 

 
2) What is the disposition effect and how can it be managed by an investor? 

The disposition effect is one where the investor tends to sell/book profit on the shares that have earned a good return and hold onto stock investments that are currently showing a loss. As investors are 'loss-averse', they hold onto the losing stocks in their portfolio for too long. Investors can manage this bias by following the practice of ‘riding the winners and selling the losers’ to achieve optimal long-term portfolio performance. The investor needs to consistently evaluate the performance of the companies and accordingly, retain companies that are delivering solid performance. 

 
3) What is the social proof bias and how can investors overcome it? 

The social proof bias occurs when an investor tends to purchase shares of a company after learning that other investors have also bought those shares. The investor takes comfort in the investment decisions of others. This also leads to a herd mentality among investors as they chase the most discussed/shared investment ideas on popular social media platforms or websites. To avoid this bias, investors need to do their own analysis of the financial performance of a company and then decide, if this particular equity investment suits their risk profile or not. 

 
4) What is the overconfidence bias and how can investors overcome it? 

The overconfidence bias is the tendency of an investor to have a strong belief that he/she is right about a particular stock investment idea. There is a tendency to believe that he/she has an investing edge over others. One example is that someone, who works in the technology industry, thinks that he/she knows a lot about technology & investing in technology companies, and as a result, holds too many technology stocks in his/her portfolio. An investor can help overcome this bias by having his/her investment ideas critically analysed by another investor/analyst so that he/she takes a more practical approach to invest in the technology sector.