What is behavioural finance?
Behavioural finance is a field of study that combines finance and psychology to understand how people make financial decisions. It recognizes that people can be influenced by biases and emotions when making financial choices. It helps to explain why investors often act against their best interests and make decisions based on personal biases instead of facts. By becoming aware of and understanding these biases, investors can take steps to make intelligent investing decisions.
Behavioural finance lists down four main factors that may help understand why people sometimes make irrational decisions: self-deception, cognitive (or errors while processing information) biases, emotional biases, and group dynamics (social influences).
Some common biases affecting financial decisions include confirmation bias, disposition bias, familiarity bias, experiential bias, and loss aversion.
What is stock market psychology?
Stock market psychology refers to the study of the overall sentiment or feeling of investors and traders towards the market at a particular time.
A wide range of psychological factors impacts investment decisions in the stock market. For example, fear can lead to panic-selling during market downturns, while greed can lead to excessive risk-taking and speculative investor behaviour. Additionally, expectations of future market trends or economic conditions can influence buying and selling decisions.
An overview of stock market psychology can help investors and traders take the right positions in the market and make wise trades. This knowledge may help them assess the reason behind a particular stock move and prevent them from making emotion-driven trades, avoid common psychological trading mistakes, and achieve long-term success in the market.
How do market psychology and investor behaviour impact the stock market?
The behaviour of individual investors can collectively have a significant impact on the stock market. Several factors influence the decision-making process of individual investors while investing in the stock market, including cognitive biases, awareness factors, and market factors. Herding behaviour, where investors follow the crowd, is a critical influencer of investor behaviour in the Indian stock market.
The best illustration of this is the way the stock indices diverged from the India growth story during the Coronavirus pandemic. While the economy was drastically impacted – factory closures, unemployment on a high, inflation gnawing away at savings, ‘doom-ish feeling’ in general, the Indian stock market, after a brief hiatus, zoomed up to new highs! The market broke many records at the peak of the virus infection. Of course, this cannot fully be attributed to irrational behaviour of investors, but it did play a large role in the revival of the Indian market.
Behavioral finance examines how psychology and emotions impact financial decisions, leading to the identification and explanation of inefficiencies and mispricing in financial markets. The field assumes that investors are not always rational and make decisions based on available information, and cognitive and emotional biases play a major role.
Investors in the Indian stock market, like those in any other market, are also swayed by emotions like fear and excitement. Those privy to market psychology may be able to prevent themselves from being way-led into making irrational decisions of buying or selling. When trading stocks, it helps to develop a trading plan which is a set of rules that outline the strategy throughout the trading process.
Additionally, social media has become an influential factor in market psychology. People interacting on social media generate information that can influence market sentiment, leading to changes in stock prices.
In conclusion, stock market psychology plays a significant role in determining stock prices and the stock market’s overall performance. The sentiment of the market can be influenced by various factors such as emotions, news, and social media, which can ultimately impact investors’ trading activity and decision-making. Overview of stock market psychology is crucial for investors to make informed decisions while investing in the stock market.