Behavioural Finance is the study of investor behaviour, which endeavours to understand and explain how investors think, act and why they do what they do. Most investors understand the concept of buying low and selling high. However, because they allow fear, greed and other emotions to influence them, they tend to stray from their principles, and this affects their decisions.
Efficient markets assume that investors are thinking rationally and are making rational decisions regarding their investment decisions. It is assumed that they are executing transactions with an intent to reap the greatest gains and the lowest losses while keeping the concept of buying low and selling high in the back of their heads. In addition, they utilise the findings of their research and other details relevant to making a decision.
Investors are not always rational thinkers though, and this reduces the efficiency of the market.
Even investors who understand behavioural finance can still be victims of this rollercoaster. However, increased familiarity will help us to avoid getting stuck in these stages. Eventually, all investors will aim to master their emotions and maximise their ability to invest rationally.
By understanding the stages of this cycle, we can understand where in the cycle we fall and tame the emotional rollercoaster, we may find ourselves on. There are 14 stages according to stock trader.com. However, the theory is based on several behavioural finance books which include: Shefrin, Hersh. Beyond Greed and Fear, Understanding Behavioural Finance and the Psychology of Investing, and Kahneman, Daniel and Tversky, P rospect Theory: An Analysis of Decision Under Risk, among others.