what is behavioral finance 
behavioral finance a subfield of behavioral economics proposes that psychological influences and biases affect the financial behaviors of investors and financial practitioners moreover influences and biases can be the source for the explanation of all types of market anomalies and specifically market anomalies in the stock market such as severe rises or falls in stock price as behavioral finance is such an integral part of investing the securities and exchange commission has staff specifically focused on behavioral finance understanding behavioral financebehavioral finance can be analyzed from a variety of perspectives stock market returns are one area of finance where psychological behaviors are often assumed to influence market outcomes and returns but there are also many different angles for observation the purpose of the classification of behavioral finance is to help understand why people make certain financial choices and how those choices can affect markets within behavioral finance it is assumed that financial participants are not perfectly rational and self controlled but rather psychologically influential with somewhat normal and self controlling tendencies financial decision making often relies on the investor s mental and physical health as an investor s overall health improves or worsens their mental state often changes this impacts their decision making and rationality towards all real world problems including those specific to finance one of the key aspects of behavioral finance studies is the influence of biases biases can occur for a variety of reasons biases can usually be classified into one of five key concepts understanding and classifying different types of behavioral finance biases can be very important when narrowing in on the study or analysis of industry or sector outcomes and results read about investopedia s 10 rules of investing by picking up a copy of our special issue print edition behavioral finance conceptsbehavioral finance typically encompasses five main concepts behavioral finance is exploited through credit card rewards as consumers are more likely to be willing to spend points rewards or miles as opposed to paying for transactions with direct cash some biases revealed by behavioral financebreaking down biases further many individual biases and tendencies have been identified for behavioral finance analysis some of these include confirmation bias is when investors have a bias toward accepting information that confirms their already held belief in an investment if information surfaces investors accept it readily to confirm that they re correct about their investment decision even if the information is flawed an experiential bias occurs when investors memory of recent events makes them biased or leads them to believe that the event is far more likely to occur again for this reason it is also known as recency bias or availability bias for example the financial crisis in 2008 and 2009 led many investors to exit the stock market many had a dismal view of the markets and likely expected more economic hardship in the coming years the experience of having gone through such a negative event increased their bias or likelihood that the event could reoccur in reality the economy recovered and the market bounced back in the years to follow loss aversion occurs when investors place a greater weighting on the concern for losses than the pleasure from market gains in other words they re far more likely to try to assign a higher priority to avoiding losses than making investment gains as a result some investors might want a higher payout to compensate for losses if the high payout isn t likely they might try to avoid losses altogether even if the investment s risk is acceptable from a rational standpoint applying loss aversion to investing the so called disposition effect occurs when investors sell their winners and hang onto their losers investors thinking is that they want to realize gains quickly however when an investment is losing money they ll hold onto it because they want to get back to even or their initial price investors tend to admit they are correct about an investment quickly when there s a gain however investors are reluctant to admit when they made an investment mistake when there s a loss the flaw in disposition bias is that the performance of the investment is often tied to the entry price for the investor in other words investors gauge the performance of their investment based on their individual entry price disregarding fundamentals or attributes of the investment that may have changed the familiarity bias is when investors tend to invest in what they know such as domestic companies or locally owned investments as a result investors are not diversified across multiple sectors and types of investments which can reduce risk investors tend to go with investments that they have a history or have familiarity with familiarity bias can occur in so many ways you may resist investing in a specific company because of what industry it is in where it operates what products it sells who oversees the management of the company who its clientele base is how it performs its marketing and how complex its accounting is behavioral finance in the stock marketthe efficient market hypothesis emh says that at any given time in a highly liquid market stock prices are efficiently valued to reflect all the available information however many studies have documented long term historical phenomena in securities markets that contradict the efficient market hypothesis and cannot be captured plausibly in models based on perfect investor rationality the emh is generally based on the belief that market participants view stock prices rationally based on all current and future intrinsic and external factors when studying the stock market behavioral finance takes the view that markets are not fully efficient this allows for the observation of how psychological and social factors can influence the buying and selling of stocks the understanding and usage of behavioral finance biases can be applied to stock and other trading market movements on a daily basis broadly behavioral finance theories have also been used to provide clearer explanations of substantial market anomalies like bubbles and deep recessions while not a part of emh investors and portfolio managers have a vested interest in understanding behavioral finance trends these trends can be used to help analyze market price levels and fluctuations for speculation as well as decision making purposes 