Podcast

Understanding investor psychology involves looking into factors such as risk, sentiment, and fallacies. The personality of the investor plays a role in their behavior, with extroverts tending to rely on external sources and introverts benefiting from observing others. Risk is defined as the probability of losing out on an investment, not just volatility. Risky investments include cryptocurrency due to the lack of information and difficulty in diversifying. Sentiment refers to public feelings about the market, with high sentiment leading to riskier decisions and low sentiment leading to more cautious choices. Investors often fall into fallacies such as escalation of commitment and the herding effect. Recognizing these psychological factors can improve decision-making and trading strategies. This is Haroon Paika, I'm your host, and today we have a very special guest, Dr. Chetty Kato. So Ishan, what are the main things to look into to understand investor psychology? I believe elements such as the underlying factors of investors' risks, sentiments, and fallacies should be looked into. Okay, what are the underlying factors of investors that play an impact on their investor behavior? So the personality of the investor should be really looked into, and certain factors like knowing how you deal with stress can be a big influential factor because people that are more prone to making impulsive decisions under stress and not staying calm and making like rational decisions can have a way tougher time investing compared to people that can't stay calm. So this is why investing can be seen as actually a mentally straining task. Another important aspect of the personality of the investor that influences their investment behavior is how extroverted or introverted they are. Sitar talks about this when he talks about how extroverts tend to ignore their internal evaluation and take more influence from outside sources compared to introverts. So this can be seen as sort of negative in a way because as investors take more influence from external factors, they spend their crucial time of making the investment decision in listening to others around them instead of seeing the charts for themselves and making their own risk-based decisions and weighing out the reward versus the chance of losing out on their investment. So it can be useful if extroverts realize this about themselves and focus on making their own decisions without looking to other people as much as they do. Introverts can have benefits if they look at how other people are doing. So before you mentioned managing risk, can you define what risk is in the investor world? So it's been defined in many ways, but the main way, as Zaisberg explains, is risk is loss probability. What this means is the chance of losing out on your investment is what determines risk instead of the popular notion that risk is actually volatility, which is not the case. They just both can be seen to be correlated. Volatility is how much the price changes in a certain time period. So what would you say are some risky investments to make? Something like cryptocurrency can be seen as a very risky investment. This is for reasons such as there's nothing to go off of. In terms of stocks, there's earning reports which show how well the business has been doing in the past, but with crypto, there's nothing like that. Also in terms of diversification, you can't really do that because the main cryptocurrency Bitcoin is basically the outline for how all the other cryptos perform and all the other ones are called altcoins. So Ethereum, for example, completely follows Bitcoin's charts and it just makes it really hard for people to diversify if everything is based off of the same thing. What is sentiment and what happens during low and high levels of sentiment? So sentiment is the general feelings of the public for a certain stock, the market in general or the economy at the time. So according to a Bacar and Wurgler study, when sentiment is high, people feel like the market is going to go up, which leads to them making more risky decisions. And during periods of low sentiment, when people think the market is going to decrease in the future, they start to make more cautious decisions with less risk, which actually leads to higher returns. So this is important to realize, this goes back to the topic of maintaining the state of being emotionless, because people usually in these times, they make more risky investments. But if they maintain the state of emotionless, they can just make the same sort of decisions in both these periods. And it can also help to recognize that in these periods of high sentiment, you should be more cautious, unlike everybody else, when the stocks can go down in this case. Okay, so what are the main fallacies investors fall into? So one of the main ones is the escalation of commitment. So this happens when usually beginner investors or investors in general, they make an investment and then they continue to invest in it because they just feel like at some point the stock will go up and they just don't want to lose out on their investment. So they either hold for a very long time or even put more money into it. And this can be very, very, very risky because it's stopping these investors from learning from their past mistakes and growing as an investor because they just keep investing in the same thing without realizing what they're doing wrong. And the next main fallacy could be the hurting effect, which is when investors look for advice from other investors and follow the exact same trades as they do without realizing the risk or the research done behind these investments to fully understand what they're going through. So do you have any concluding statements to make? Yes, so to wrap things up, understanding the psychology of investors can vastly improve our decision-making process. And by looking into how the personality of the investor affects the investment behavior and understanding the definition of risk as a loss probability can help us avoid common mistakes. Additionally, analyzing market trends and sentiment aids us in making more informed predictions on the future prices. Overall, these integral parts aid us in understanding the psychology of investors, which allows us to recognize and avoid fallacies and add crucial information to their trading strategies to make a profit. Thank you for appearing on our show. It was a pleasure having you and have a good day.