Everyone thinks there are only two parties to every trade: a buyer and a seller. That is not true. There are actually three: you, whoever buys or sells in response to you, and your own distinctive psychology that permeates the transaction.
Until recently, practitioners and scholars viewed the psychology of investing with some derision. They viewed the markets through mathematical models; soft sciences were not of much import. And then in 2002, Daniel Kahneman became the first psychologist to be awarded the Nobel Prize for Economics. A Nobel Prize apparently does wonders for helping an idea gain acceptance, especially at tradition-bound business schools whose professors can be resistant to new ideas. Ever since, the study of how emotion and psychology influence investment decision-making has steadily entered the financial mainstream. Many of the pioneers of behavioral finance, including Kahneman, are still alive. They include Terrence Odean, Richard Thaler, and Colin Camerer. Some may win Nobel prizes in the future.
It is arguably easier to analyze stocks than the human mind. To wade through the ideas of psychologists and behavioral economists is to journey into regions that seem to have no end. But in investing, one must think with probabilities, make decisions, and act, and it is clear that some major psychological pitfalls hurt most investors most of the time.
Most investors believe they know more than they do. They think that their experiences enable them ...