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BF W6: Behaviour Mistakes in Selection of Investments - Coggle Diagram
BF W6: Behaviour Mistakes in Selection of Investments
Salience effect
Definition
indi's attention is drawn to those payoffs which are most different and salient
Reason
avalability bias
representative bias
ex
we buy stocks with salient upside returns and neglect stocks with salient downside returns
however
other investors will also invest in salient upside returns stock -> stock overvaluation -> value decrease in the future
should not buy
whereas
stocks with salient downside returns receive less attention -> lower price than intrisic value -> will rise to its true value in the future
should buy
Lottery preference
investors generally prefer
lottery stocks
low current price
high volatility
right skewed return (mostly negative but there are some chances of extremely high return)
probability distortion
implication
market timing (buy, hold, sell) is important when investing in lottery stocks
buy lottery stock in Nov ỏ early Dec (before New Year effect) then sell immediately in Jan. Because lottery stock usually outperforms in Jan
short lottery stocks in Jan, then buy back in Feb, and March because then the price decreases
buy IPO stocks but just hold for 1 day
problem
lottery stocks tend to underperform
Affect heuristic
Definition
rely on emotion rather than concrete facts to make decisions/buy stocks
save energy by making conclusions quickly but can distort thinking and make wrong choice
Reason
system 1, gut feeling -> save energy
emotions can affect our risk assessment -> influence behavior
Implication
stock of a firm you like
=/=
good firm
=/=
good investment
because
a stock is good when its mispriced -> opportunity to arbitrage
Under diversification
Implication
you should hold diversified portfolio and not just invest in 1 market
level 1: only invest in 1 market (stock bond) and neglect others (commodity, cryptocurrency)
level 2: only invest in familiar stocks, local stocks rather than foreign stocks
Post earnings announcement drift PEAD