Market Psychology & Behavioural Finance — 55 Terms Defined

Action Bias Market Psychology & Behavioural Finance qualitative The tendency to prefer doing something over doing nothing, even when action has no expected benefit. Test: activity is undertaken without evidence that it improves the expected outcome

Analysis Paralysis Market Psychology & Behavioural Finance qualitative The inability to reach a decision because of excessive information gathering and deliberation. Test: additional information is sought after the point at which it stops changing the decision

Anchoring Bias Market Psychology & Behavioural Finance qualitative The tendency to rely too heavily on an initial reference number when making subsequent judgements. Test: estimates shift systematically toward an arbitrary starting value that carries no information about the answer

Animal Spirits Market Psychology & Behavioural Finance qualitative Keynes's term for the instinctive optimism that drives economic and investment activity beyond what calculation justifies. Test: investment and risk-taking rise or fall more than changes in measurable expected returns can explain

Authority Bias Market Psychology & Behavioural Finance qualitative Assigning greater weight to an opinion because of who expressed it rather than because of its evidence. Test: the persuasiveness of a claim rises with the speaker's status, independent of the reasoning offered

Availability Bias Market Psychology & Behavioural Finance qualitative The tendency to judge probability by how easily examples come to mind rather than by actual frequency. Test: perceived likelihood tracks the vividness and recency of remembered examples rather than base rates

Base Rate Neglect Market Psychology & Behavioural Finance % Ignoring the underlying frequency of an outcome when assessing a specific case. Test: a judgement uses case-specific detail while disregarding how often the outcome occurs in the relevant population

Behavioural Finance Market Psychology & Behavioural Finance qualitative The study of how psychological factors cause investors and markets to depart from purely rational decision-making. Test: the observed behaviour departs systematically from what expected-utility maximisation would predict, in a documented and repeatable direction

Capitulation Market Psychology & Behavioural Finance qualitative The point in a decline at which remaining holders abandon their positions, typically on heavy volume. Test: a sharp price fall on unusually high volume, accompanied by broad negative sentiment and heavy redemptions

Confirmation Bias Market Psychology & Behavioural Finance qualitative The tendency to seek and favour information that supports an existing view while discounting information that contradicts it. Test: evidence supporting the held position is sought and accepted readily, while contrary evidence is scrutinised or dismissed

Contrarian Investing Market Psychology & Behavioural Finance qualitative Deliberately taking positions against prevailing sentiment, on the argument that consensus is already in the price. Test: the position is taken because sentiment is one-sided, with an independent basis for believing the consensus is wrong

Data Mining Market Psychology & Behavioural Finance ratio (x, times) Searching data for patterns until something appears significant, without a prior hypothesis. Expected False Positives = Number of Independent Tests x Significance Level

Disposition Effect Market Psychology & Behavioural Finance qualitative The tendency to sell winning positions too early and hold losing positions too long. Test: the proportion of gains realised exceeds the proportion of losses realised, across a portfolio over time

Dunning-Kruger Effect Market Psychology & Behavioural Finance qualitative The tendency for people with limited competence in a domain to overestimate their ability in it. Test: self-assessed ability is highest relative to actual ability among the least skilled, because assessing skill requires the skill itself

Endowment Effect Market Psychology & Behavioural Finance qualitative The tendency to value something more highly simply because one owns it. Test: the price demanded to sell an item exceeds the price the same person would pay to buy it

Euphoria Market Psychology & Behavioural Finance qualitative A state of widespread optimism in which risk is discounted and price rises are treated as normal. Test: rising participation, leverage and new issuance combine with a narrative explaining why traditional valuation no longer applies

Familiarity Bias Market Psychology & Behavioural Finance qualitative Preferring investments one recognises, treating familiarity as a proxy for safety. Test: the allocation favours known names or sectors without a corresponding analytical basis

Fear Market Psychology & Behavioural Finance qualitative The emotional response to potential loss that leads investors to reduce exposure or avoid it entirely. Test: exposure is reduced or avoided on the basis of recent price movement rather than on a changed assessment of the asset

Fear of Missing Out Market Psychology & Behavioural Finance qualitative The anxiety of being left out of a rise that others are participating in, leading to purchases made without analysis. Test: the decision to buy is triggered by others' gains rather than by any assessment of the asset's value

Framing Effect Market Psychology & Behavioural Finance qualitative The tendency for a decision to change depending on how the identical information is presented. Test: preferences reverse when the same outcome is described as a gain rather than as a loss, or in different units

Gambler's Fallacy Market Psychology & Behavioural Finance qualitative The belief that an independent random outcome is due to reverse after a run in one direction. Test: the predicted probability of the next outcome changes on the basis of prior independent outcomes

Greater Fool Theory Market Psychology & Behavioural Finance qualitative The idea that an overpriced asset can still be bought profitably if someone else will pay more for it. Test: the purchase is justified by an expected resale price rather than by the asset's own cash flows or utility

Greed Market Psychology & Behavioural Finance qualitative The desire for larger gains that leads investors to take risks they would otherwise decline. Test: position size, leverage or concentration rises without any change in the analysis that justified the original exposure

Herd Behaviour Market Psychology & Behavioural Finance qualitative The tendency to follow the actions of a larger group rather than one's own analysis. Test: the decision follows what others are doing, without independent evidence being gathered or weighed