The process of deciding to sell a stock is a difficult one unless an investor has developed a methodology.

The process of deciding to sell a stock is a difficult one at best unless an investor has developed a methodology and adheres to it mechanically in order to avoid inevitable internal mental battles.  

When a loss is involved, the sell decision is even more difficult because the issue of pain-avoidance is now present.

It is human nature to seek self-preservation, and pain is a phenomenon that indicates a danger to well-being.

Some investors are obsessed with safety, but most are reasonably balanced in their tolerance of the risk involved in earning a profit.  But every investor has some threshold at which pain is avoided, sometimes at ridiculous cost.  

Dealing with an investment or trading loss involves not only financial pain, but also ego pain.  A majority of shareholders at some point attempt to avoid both pains by failing to deal with the reality of their losses.  

One of the most convenient ways to avoid the pain of loss - or even of profit squandered - is denial.  They prefer not to think about it, or they minimize it.  

When specific stock positions go bad, the pain-avoider becomes a longer-term holder who is more accurately a collector of stocks.  He has no real investment motive or astuteness of value judgement and is, in fact, simply denying the pain of potential loss.

Behavioural Finance

Behavioral Finance

By Albert Phung

Whether it's mental accounting, irrelevant anchoring or just following the herd, chances are we've all been guilty of at least some of the biases and irrational behavior highlighted in this tutorial. Now that you can identify some of the biases, it's time to apply that knowledge to your own investing and if need be take corrective action. Hopefully, your future financial decisions will be a bit more rational and lot more lucrative as well.

Here is a summary:

• Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining.
  
• Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler.
  
• The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand.
  
• Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and intent.
  
• Seeing is not necessarily believing as we also have confirmation and hindsight biases. Confirmation bias refers to how people tend to more attentive towards new information that confirms their own preconceived options about a subject. The hindsight bias represents how people believe that after the fact, the occurrence of an event was completely obvious.
  
• The gambler's fallacy refers to an incorrect interpretation of statistics where someone believes that the occurrence of a random independent event would somehow cause another random independent event less likely to happen.
  
• Herd behavior represents the preference for individuals to mimic the behaviors or actions of a larger sized group.
  
• Overconfidence represents the tendency for an investor to overestimate his or her ability in performing some action/task.
  
• Overreaction occurs when one reacts to a piece of news in a way that is greater than actual impact of the news.
  
• Prospect theory refers to an idea created by Drs. Kahneman and Tversky that essentially determined that people do not encode equal levels of joy and pain to the same effect. The average individuals tend to be more loss sensitive (in the sense that a he/she will feel more pain in receiving a loss compared to the amount of joy felt from receiving an equal amount of gain).
  

Table of Contents
1) Behavioral Finance: Introduction
2) Behavioral Finance: Background
3) Behavioral Finance: Anomalies
4) Behavioral Finance: Key Concepts - Anchoring
5) Behavioral Finance: Key Concepts - Mental Accounting
6) Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
7) Behavioral Finance: Key Concepts - Gambler's Fallacy
8) Behavioral Finance: Key Concepts - Herd Behavior
9) Behavioral Finance: Key Concepts - Overconfidence
10) Behavioral Finance: Key Concepts - Overreaction and Availability Bias
11) Behavioral Finance: Key Concepts - Prospect Theory
12) Behavioral Finance: Conclusion