Investment is a rational decision based on an analysis of several factors. Several recent studies have shown that financial investment is influenced by many irrational factors related to feelings or perceptions. The analysis of these varied factors involves what is now called the psychology of finance. What is it about?
Irrationality and investors
Investors do not always decide rationally. Many factors come into play, and there are chances that they can go all irrational, even on decisions involving huge risks. Many factors influence investors’ decisions, from cognitive biases to confirmation biases, mental accounting biases, and emotional biases.
Sometimes investors decide on herding.
For example, when the stocks are going up, they will do all in their might to buy them. And there are many more irrational decisions that they make. According to psychologists, people make loads of mistakes related to finances. So, your gut feeling can be your new best friend.
Often, our intuitions can keep us protected from severe inconveniences. For example, when we decide, and the results are not what we aimed for, and we look back on all the options, we tend to remember all those intuitions that could have led us to the right results. Therefore, investors are primarily irrational about their decisions.
Psychology of finance- The measure of investor sentiment
Psychological influence in deciding financial matters is also called Behavioral finance study. The psychology of finance is a new discipline that can measure and analyze investors’ views.
Indeed, finance sentiment is considered “all expectations of investors not justified by economic fundamentals.” In other words, these are all factors that do not respect traditional economic paradigms but that influence the investment decision.
It can be feelings of pessimism or optimism, such as mimicry, overconfidence, misperceptions. The sentiment is synonymous with an error in finance because it is not based on fundamental financial indicators.
Moreover, contrary to the financial indicators, the feeling is difficult to quantify because of its subjective and individual character. The psychology of finance involves several methods of measurement mobilized in the natural and social sciences. But recently, it turned out that the Internet was one of the most effective predictive metrics.
Since these feelings are subjective, these will not have quantifiable resources, reasons, or solutions. Investors, based on their intuitions and while considering the overall situation, will make these decisions. They might not be confirmed about the outcomes but will have a strong feeling about the positivity of the results.
Internet as a method of measuring investor’s sentiment
Most social and natural sciences have been used to calculate an investor’s view. However, studies have shown that the flow of searches in search engines and social networks is among the most reliable methods.
Indeed, most investors use the Internet when it is interested in a title, allowing to refine the paradigms of the psychology of finance; this implies that research volumes can be an indicator of economic activity.
Tracking the systematic searches allows you to know how much investors are paying attention to specific securities. Also, the increase in research volumes on the theme of budgetary crisis makes it possible to predict with certainty the imminent evolution of exchange rate volatility.
It is the same for social networks. In this regard, studies have also linked the mood of Internet users and the profitability of the stock markets. And then again, it is always beneficial to be informed of the available resources before acting. It is, therefore, through these results, that the investors decide whether to invest or not.
The higher the volume of queries on specific terminologies, the more it is possible to determine whether investor sentiment tends towards pessimism or optimism. The greater the number of requests for the word crisis, the more it reflects a feeling of discouragement, i.e., Google Trends Negative Sentiment (GTNS).
GTNS explains the feelings of stress and uncertainty that drive investors. The same is true for other words with opposing economic and financial connotations such as debtor, deficit, bankruptcy, inflation, liquidation, poverty, and recession.
Bottom line
Human psychology has a sufficient role to play in important matters. Decisions that require thorough research and plans, we tend to make them based on our intuition. Even in financial matters, investors’ decisions are based on their psychology.
So, the next time you are confused about what to put forth your investor, consider his behavioral aspects too. You will get to influence some of the most significant decisions of his life.
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