What is stock market investment? It’s a rather rational and objective business that depends on all the data and financials, driven by trends in the market till we remember. Honestly speaking, however, investors’ decisions are more commonly and often swayed more by feelings, biases, and other psychological variables rather than by pure rationality. But lurking in the wings of this movement called behavioral finance is a plot in which psychology and economics come together to make a case for the rationality underlying some illogically-sounding-or at least, in violation of best practice-financial decisions people make.
After all, there is hardly any investor and analyst today who does not know of this field-behavioral finance, in the Indian stock market-in these times when retail investor participation has increased rapidly in the last decade. Whether it is euphoria in a bull market or fear of correction in the market, psychology propels the market trends, creates volatility, and determines the outcome of an investment.
Let’s discuss how behavioral finance plays out in the Indian market and a few common biases and emotions that affect the investors and through which psychological factors can be used as an indicator of better decision making for this blog post.
1. What is Behavioral Finance?
Behavioral finance is the impact that mental factors as well as cognitive errors have on investment decisions made by individuals as well as institutions. This concept has no connection with traditional finance theory-the framework through which investors are viewed as rational or purely and only information-based when coming to a conclusion about an investment decision. It assumes that such investment decisions are highly contingent upon emotions, cognitive bias, and social pressure.
Behavioral finance explains why even experience holders sometimes err in India, which incidentally is that place where day after day, retail investor numbers in the Indian stock market are on a rise. Decisions taken under fear, greed, overconfidence or herd mentality have a very large influence on the way stocks behave.
2. Common Behavioral Biases in the Indian Stock Market
It will be based on the investments, if these have been brought upon prevailing psychological biases towards such investment those one can find influential over its investments thus proper understanding of that these factors are the basis which explains how they affect such poor financial outcomes. Following are some of the basic and most common behavioral biases of an Indian market:
Overconfidence bias
What It Is:
Overconfidence is the ability of an investor to predict the future movement of prices in the market or the directions at any time. Overconfidence mainly arises because investors think that they are better informed than others; therefore, they have to invest more than they would if the condition were normal.
Effect on Indian Investors:
Indian retail investors in bull markets would normally be overly confident of the stock picks, based on some recent success or media hype. Such overconfidence means some pretty bad decisions to them, such as trading too much or holding on to losers for far too long, hoping against hope that they will rebound.
Crowd Psychology
What Is It Herd mentality is the tendency of people: to see what other people are doing, and so lead their lives; they do not actually know what they ought to do. This usually occurs during boom or bust periods in the markets.
How This Affects the Investor in India Indian investors exhibit herd behavior, particularly in boom and bust market conditions. For instance, in the COVID-19 crash of 2020, panic sales through retail investors were witnessed in fear of further losses with no truth in sight out there on underlying fundamentals. In the case of bull markets in 2017-2018, it is argued that panic investing happens because of herd mentality and FOMO as investors invest in exuberant and overly valued stocks and sectors.
Loss Aversion
This phenomenon is called loss aversion: people lose more over what they have lost than what they could have gained. Having such a behavior bias, the individuals end up holding on to losing investments in the hope that something might come along and make it recoverable, thus letting go and cutting their loss.
Indian Investors:
In India, retail investors are holding onto those stocks that have performed very poorly in the hope that they might turn profitable sometime in the future. This leads to huge accumulation of unrealized losses and also prevents investors from redeploying their funds elsewhere by crossing over from such underperforming stocks to more promising ones.
Anchoring Bias
What is it? Anchoring is fixing oneself to some special piece of information-from the historical price of a stock to a target price-and then using that anchor in deciding future things even though it may no longer have relevance.
Indian Investor Effect For instance, the equity stock purchaser that is purchasing at ₹1,000 may refuse to sell the equity stock when the fundamentals begin to degenerate simply because his expectation is anchored at the price of purchase. The same is now held to be among the most powerful biases because it makes entry and exit timing suboptimal.
Confirmation Bias
What is it? Confirmation bias:
The tendency to scan for, interpret, favor and remember information in ways that confirm one’s prior belief, and to avoid information that contradicts these beliefs.
It could lead Indian investors to hold an opinion-sustaining view of an equity, sector, or whatever focus they want to invest in and selectively highlight news or data that confirms the
view to the exclusion of red flags or contrary opinions. This is at a very basic level, enough to be a hindrance to proper diversification and overly concentrated portfolios.
3. How do emotions enter into investment decisions?
Here emotions dominate investment decisions, people reach extremes irrationality. For example, in the country of India, where the cycle of news, market rumors as well as social media paints the sentiment of investors, it does make a thing important to know what eventually drives the emotional markets.
Fear and Greed
Fear : It instills panic selling instincts in an investor based on the fear of losing his money. It deprives the investor of the benefits of subsequent market recovery capitalizations. Such selling is normally made, therefore, from the effects of fear and often occurs on the precipice when markets are volatile.
Or, vice versa, greed tips the other end of the see-saw wanting to invest in equities since they pay out unusually high returns with little or no regard to risk. That is very highly visible when money gets really invested into stocks or segments of the market purely due to the speculation of the situation and not very much due to analysis.
FOMO – Fear of Missing Out
What Is It – FOMO stands for Fear of Missing Out, and it is a very potent emotional motivator that drives investors into action from the subconscious fear of missing out on a “golden opportunity.”.
Indian Investor Impact:
Now imagine that rally happens to be in an asset class like technology, real estate, or gold, and an Indian investor is entering that asset class without his due diligence of research. That emotional bite can make him overpay for stocks or an asset that happens to lack adequate fundamental strength
4. How Behavioral Finance Explains Market Cycles
The Indian stock market is normally quite cyclic, boom and bust period. Again, this is a result of behavioral finance: why do cycles get so shockingly exaggerated so often? Once again, a bull market appears that sends stock prices to heights that are unsustainable through investor optimism, overconfidence, and herd behavior. Thus, in a bear market the fear of losses makes people sell out of panic and hence under these circumstances such prices may go lower than that warranted by the economic condition.
Bull Market Psychology:
The bull runs of psychology create news that would rally the market on an expectation of continuously higher prices or equity levels. More and more people come in to invest when they perceive this market, leading to an unrealistically optimistic nature in it, promptly turning speculative in character and fueling asset inflation.
Bear Market Psychology:
Bad news, falling prices, and rising uncertainty escalate into a high level of fear, panic, and even hysteria in the bear market. Loser-averse investors sell at the worst times and make it much worse.
5. Overcoming Behavioral Biases
Though the investor can gain a logical mind knowing how behavioral biases can be overcome and restricted, here is the list of strategies for overcoming biases:
Clear goal towards investments: Long-term plans and that is resistant to the shock of an investment plan can reduce the influence of a short-term emotion of fear and greed while investing.
Diversification:
Diversification in the portfolio may reduce the effect of over confidence or confirmation bias.
News and Education: Continuous education about financial markets, trends, and investment strategies would make an investor avoid all forms of herding behavior and make appropriate decisions.
Patience in the Market:
Such an investment should not react impulsively towards the market movements. Considering long-term financial objectives, emotional swings of the market would not be entertained.
Conclusion:
Behavioral Finance in the Indian Market
This field of study-that is, behavioral finance-is a very prolific field of study on how such shifting and inconsistent logic would persuade investors to frequently stand against the principle of rational investment. Now, in that context, there are many more psychological reasons, cause investment behavior toward eventual success in investing in the marketplace like India, where participation is on the rise in the form of retail participation and emotions can run very high. And, therefore, all these common biases, like over-confidence, loss aversion and herd mentality would ensure that investors are pretty able to navigate through markets. Indian investors can surely avoid such emotional pitfalls while investing for long term financial goals if they adopt discipline, education, and long-term thinking.