Besides the traditional disadvantages faced by retail investors compared to large investors, they also face psychological challenges such as loss aversion and gambler's fallacy when investing in stocks, according to Curtis Yeung Wan-yui, a strategist from UOB Kay Hian (Hong Kong).
Behavioral finance, an extension of behavioral economics, suggests that stock prices are not solely determined by intrinsic value, but are heavily influenced by the behavior of investors, Yeung shared his experience with some business journalism students at Hong Kong Baptist University yesterday. This field integrates knowledge of finance, psychology, behavior, and sociology to understand that retail investors, who are limitedly rational, often make mistakes.
According to Yeung, loss aversion is the biggest psychological challenge for retail investors. Retail investors are often hesitant to acknowledge losses and prefer to take high-risk chances in an effort to avoid them, instead of making timely decisions to stop losses.
When the stock price continues to decline, executing a sell order becomes equivalent to acknowledging defeat and loss, leading to psychological distress. Some retail investors try to avoid this by holding onto their shares instead of accepting the defeat and the accompanying loss.
A consequence of loss aversion is that investors become fixated on past investment objectives and fail to consider new investment opportunities.
Retail investors often exhibit other detrimental psychological tendencies, such as the gambler's fallacy and herd mentality.
To make smart investment decisions, it is crucial to approach the market with rationality and not be swayed by the actions of others. Additionally, the market is constantly evolving, so it is important to avoid having preconceived notions about a particular stock and to stay up to date with the latest developments.
