Imagine finance as a grand opera, where not just the composed notes but also the intricate emotions define the performance. To master it, one must tune into both the mathematical rhythms and the psychological cadences.
Overconfidence manifests more during bull markets, leading to the illusion of control. Investors often believe they can time the market, a dangerous assumption proven wrong repeatedly. The internet bubble of the late 1990s and the housing market crash in 2008 serve as glaring examples. In both cases, investor overconfidence led to speculative bubbles that eventually burst, causing widespread financial ruin.
Despite the S&P 500 yielding an average annual return of about 12%, most individual investors realise a mere 2-3%. This gap is often attributed to psychological biases outlined in prospect theory.Confirmation bias is a cognitive bias that occurs when investors tend to seek and interpret information in a way that supports or confirms an existing belief, or they’ll disregard information that contradicts their beliefs.
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