So why do so many investors make mistakes?
Neuropsychologist think the reason why investors make mistakes has to do with their brain’s design. Put simply, the “normal” brain is wired to avoid pain and seek pleasure.
“These natural instincts are powerful. But while they were extremely useful when we were hunter-gatherers these same instincts can be very troublesome when making financial decisions”, Visual Capitalist.
Investors/traders make mistakes because of their desire to satisfy these basic human instincts, to avoid pain and seek pleasure
A trader/investors instinctive reaction to sitting on losses is to cut and run. “Run for the hills” is a typical flight response to suffering losses. Traders will instinctively try to save himself/herself from bleeding capital and avoid further pain by exiting a loss-making position.
As Darren winters explains, investors make mistakes when driven solely by their instincts. However, there are sometimes usual situations when going on gut instincts alone can yield good results. A gut instinct is an instinctive feeling, as opposed to an opinion or idea based on facts. Older human traders tend to rely on their gut instincts more than younger traders.
Professional traders/ investors make mistakes less frequently because they are able to suppress the fight-flight instincts by using technical analysis in their decision making. Trend lines showing support levels, moving average and technical patterns all help to take the fear out of trading and thereby suppress the survival instinct that could also be a red herring.
Investors make mistakes because of a cognitive bias which makes it difficult to invest rationally. For example, seeking confirmation of your own beliefs
“Our minds love proof of how smart we are” So investors make mistakes because their minds are hardwired to see facts that support their view while they block out facts that make them look foolish.
Investors make mistakes even more so today because of the online echo chambers of the modern world. Google and Facebook filter our results, thereby they reinforce an investors view, which could be false. News media all tend to favor one point.
Investors make mistakes because their minds are imprisoned in an echo chamber
If they are bullish and seek “information” their minds will be bombarded with bullish news and vice versa. Perhaps the digital world is creating extremism of ideas if so this would be dangerous for investors.
Investors make mistakes less frequently by “stress testing their ideas”.
“The power of thoughtful disagreement is a great thing” Ray Dalio.
Being overconfident is another reason why investors make mistakes
Overconfidence is a common cognitive bias. We constantly overestimate our abilities, our knowledge, and our future prospects. So remain humble.