I had recently written two articles ( here and here) on behavioural finance that discussed six different types of psychological biases which could affect our investing behaviour and impair our ability to make good decisions.
But apart from biases, there are also two categories of psychological influences which can impair judgement and wreak havoc on our investment process. The categories are fallacies and illusions. The latter group refer to a distortion of our senses, and illusions warp our perception of reality. This article shall focus on three kinds of illusions which investors should be wary of.
Illusion of control
When it comes to money matters and investing, the illusion of control seems to manifest itself fairly often. This is the tendency for people to over-estimate their ability to control events or outcomes.
Investing is a probabilistic exercise where we need to rely on insights and rigorous analysis to come up with conclusions to support our investment theses. It is also an exercise where we should focus on the process, rather than outcomes. Investors suffering from the illusion of control feel that they can control the outcomes of their investment decisions when in reality, there are myriad factors at play, including luck. Having the illusion of control may cause an investor to feel over-confident and plough too much money into an investment idea, with the erroneous assumption that he can influence the investment’s outcome.
Jumping to conclusions
Jumping to conclusions is a case of us believing we possess superior knowledge, which leads to us taking shortcuts when making investment decisions. We may also tend to put too much weight on information we have obtained through hard work – in such an instance, armed with what we think is “superior” knowledge, we may then let our guard down and may make poor investment decisions.
Clustering illusion is the belief in the existence of patterns where none exist. This psychological illusion can usually be found among chart readers (i.e. practitioners of technical analysis) who claim they can identify stock market patterns within the lines and squiggles of price charts, even though none may actually exist.
I will not go so far as to say that a chart reader is delusional. But the brain does frequently play tricks on us by leading us to “see” patterns among seemingly random, unrelated phenomena. Just think of how you can somehow see familiar faces or shapes when you look at clouds floating in the sky, and you can get an idea of how prevalent this illusion is.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.