a portrait of the individual investor

A portrait of the individual investorBehavioral finance

Small individual investors are ‟dumb”

″Only two things are infinite, the

universe and human stupidity, and

I'm not sure about the former.″

Albert Einstein

Noise traders

also known as „idiot trades” - stock traders whose decisions to buy, sell, or hold are irrational and prone to judgement and decision-making errors.

How do small individual investors trade stocks and how do they think about their

own equity portfolios?

Types of errors

1. Discovering naive patterns in the past

price movements;

2. Sharing popular models of value;

3. Lack of proper diversification of equity

portfolios;

4. Irrational trading decisions.

Naive patterns in the past price movements

GOAL: To spot trends and turning points

Judgement errors:

• extrapolation bias – expecting continuation of past market trends

• perception of the likely variability of the future stock prices

Popular models of value

• Sharing mental frames – common perception of investment options popularized in media, tips from friends and recommendations from financial advisors.

• Good stocks vs. good companies

• Favouring familiar gambles

Diversification pays

Diversification allows for higher returns without having to accept higher risk.

• Illusion of control - „I don’t gamble, I take calculated risk.”

• Most investors are underdiversified.

• „Pyramid model”

Prospect theory

Irrational trading practices

• Disposition effect - Investors tend to realize gains on past winner stocks and avoid realizing losses - tax ineficiency.

• Investors tend to trade shares on impuls without prior planning.

Good luck in managing your portfolios.

Eliza Zisopulu