(This is the last part - III - of three Instablogs on Behavioral Finance)
A newer field of research related to Behavioral Economics and Finance are advances in Neuroscience:
Neuroscience research demonstrates how these emotions originate in the brain's center of emotional processing, the limbic system, in various financial situations. We can learn to identify these emotional disturbances in our financial reasoning. Distorted reasoning is often characterized by intense feeling. However, unless we make a conscious effort to become aware of our feelings, we can easily succumb to their destructive tendencies.
Often, when considering potential gains, our reasoning is distorted by high levels of excitement, hope, and greed. When thinking about potential losses, our reasoning is distorted by high levels of worry, fear, and recent pain. As greed dominates our thought process, we're likely to take on more risk than anticipated. When experiencing strong greed, we often excitedly rush into investments. As fear dominates our reasoning, we're likely to take on less risk than optimal. When fear is at an extreme, we may attempt to gain relief through the panicked selling of painful ("bleeding") positions.
This topic is too complex to discuss it in a short Instablog entry.
I will therefore link to a good presentation from Barry Ritholtz, it covers many examples of Behavioral Finance and Neuroscience in Finance.
Those interested can read more about the keywords listed below on their own:
A) Behavioral Economics
1. Herding, Groupthink
2. Experts: Articulate Incompetents
3. Optimism Bias
4. Confirmation Bias
5. Recency Effect
6. Emotions impact perception
7. Anticipation vs. Rewards
8. Selective Perception & Retention
9. A Species of Dopamine Addicts
10. Endowment Effect of Ownership
11. Monkeys Love a Narrative
12. Cognitive Errors Impact Processes
His full presentation slides can be found here:
To finish off, a familiar picture for many investors may serve as a simple summary on the topic:
(Source: behaviorgap.com/ )
I hope readers change (or at least understand) their behavior before going through too many of these greed and fear cycles :)