The more you know about your psychological biases, the better you can function in the volatile stock market.

Everyone has opinions and psychological biases.  However, people may not know their own biases.

The more you know about your psychological biases, the better you can function in the volatile stock market.

The entire market may be influenced by psychological reasons, not by fundamental reasons alone.

From an investment perspective, the bottom line is that the market will continue to fluctuate and give you solid opportunities every so often.

Value in the long run is determined by fundamentals, while short-term gyrations reflect market participants' psychological weaknesses, such as herding.  

Knowledge is the best antidote to making wrong decisions.

If you are a long-term investor, the rational thing to do is to make decisions based on long-term fundamentals of the business.

Behavioural Finance: Heuristic-Driven Biases

The important heuristic-driven biases and cogniive errors that impair judgement are:

• Representativeness
• Overconfidence
• Anchoring
• Aversion to ambiguity
• Innumeracy

1. Representativeness

http://myinvestingnotes.blogspot.com/2008/09/heuristic-driven-biases.html

Representativeness refers to the tendency to form judgements based on stereotypes. For example, you may form an opinion about how a student would perform academically in college on the basis of how he has performed academically in school

2. Overconfidence

http://myinvestingnotes.blogspot.com/2008/09/heuristic-driven-biases-2.html

People tend to be overconfident and hence overestimate the accuracy of their forecasts. Overconfidence stems partly from the illusion of knowledge.

3. Anchoring

http://myinvestingnotes.blogspot.com/2008/09/heuristic-driven-biases-3-anchoring.html

After forming an opinon, people are often unwilling to change it, even though they receive new information that is relevant.

4. Aversion to Ambiguity

http://myinvestingnotes.blogspot.com/2008/09/heuristic-driven-biases-4-aversion-to.html

People are fearful of ambiguous situations where they feel that they have little information about the possible outcomes. In experiments, people are more inclined to bet when they know the probabilities of various outcomes than when they are ignorant of the same.

5. Innumeracy

http://myinvestingnotes.blogspot.com/2008/09/heuristic-driven-biases-5-innumeracy.html

People have difficulty with numbers.