Psychological biases lead to market overreaction and underreaction, and it can be difficult to discern which is happening at any given point, according to a recent article in Bloomberg.
“For an investor, the idea that other people are making poor decisions is a tantalizing one,” the article states, which raises the question of if and how the predictable irrational behavior of humans can translate into stock market patterns that can be exploited by traders. ”
The article asserts that when people can’t understand what’s happening in the markets they “turn to psychological phenomena to try and explain it.” It cites examples of funds that attempt to “capitalize on the behavioral biases of investors,” such as those funds overseen by behavioral economist Richard Thaler (who was just awarded the Nobel prize in economics), but points out that even though such funds can perform well, it’s tricky to parse out how much of performance is tied to behavioral factors.
Outlining insights shared by such industry experts as Raife Giovinazzo (lead portfolio manager of the Fuller & Thaler fund), Ben Inker of GMO and Stephen Wendel of Morningstar, the article offers varying points of view and influential factors as well as strategies used to address them.