Are emotions always a bad thing in investing?

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Meeting Investors' Goals

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University of Geneva

Meeting Investors' Goals

904 classificações

Curso 2 de 5 em Specialization Investment Management

In this course, you will dive into the concepts of rationality and irrationality and understand how they impact our investment decisions and what the consequences can be at the market level. You will first explore the different biases that we, as humans, are subjected to when facing investment decisions and how they may impact the outcomes of these decisions. Moreover, you will see how emotions and ethical concerns such as honesty and trust influence market participants. When they are considered as a group rather than individually, you will discover how rationality and irrationality can drive asset prices to and away from their fair value. Finally, you will be presented with different portfolio construction methodologies and investment styles that make up the landscape of today's portfolio management industry. At key points throughout the course, you will benefit from the practical knowledge of experts from our corporate partner, UBS, in how to build and manage clients' portfolios.

Na lição

How Individuals Make Financial Decisions

The focus of this second week is on you, the investor: what are the reasons you participate in financial markets? How do you make investment decisions? What can go wrong in your decision process and what are the consequences? What can you do about it? To answer these questions, we will talk about cognitive biases, emotions and moral values and their respective link with investment decisions.

Honesty and trust in investment decision making - Study design10:09

Honesty and trust in investment decision making - Study results5:54

Impact Investing - UBS guest speaker4:38

Are emotions always a bad thing in investing?4:39

Conheça os instrutores

University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Kerstin Preuschoff
Associate Professor of Neurofinance and Neuroeconomics
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute
University of Geneva- Philip Valta
SFI Assistant Professor of Finance
Geneva Finance Research Institute

[MUSIC]

Are emotions always bad for investment decisions?

Not surprisingly, the answer is it depends.

The good news is that's there's no need to suppress your emotions,

if you want to trade in the market.

In fact, as we've seen before,

even professional traders respond emotionally to market events.

The key is to first, identify your emotional and physiological responses to

market events and then find the right balance between reason and emotion.

Remember that our brain is constantly trying to predict what's going to

happen next in the world.

It's constantly trying to fill in information that's missing.

Now this filling in process, this process of inferences is heavily

influenced by our past experiences and by all past and present emotions.

The interesting thing is that it works surprisingly well,

especially in simple situations.

So when we make intuitive decisions, they're often surprisingly good.

The problem is that financial markets are not simple, they're rather complex.

More importantly, financial markets are somewhat unnatural.

That is the goals, the structure, the principles that underlie financial markets

are very different from the environment that our brain has evolved for.

As a result,

our brain makes a lot of wrong assumptions about the structure of the market.

As a result, you're particularly prone to cognitive biases and

misleading emotional information,

because the financial market violates many basic principals of nature.

Let's say,

you want to approach the financial market from purely rational perspective.

And if you have the statistical skills, you may say, okay.

I'm going to take the data of the last five years, all the data and I'm going to

try and look for any indicators that would have predicted market movements.

Now the thing is if you do this, you will find such indicators.

In fact, you will probably find a few dozen of them and

you will make yourself believe that you can really predict based on these

indicators how certain stocks are going to move.

The problem is if I was to generate at random, an equally large dataset

representing five years of market data and I gave you that to analyze.

You would also find, probably dozens of correlations and

strategies within that dataset.

The problem is that this is a dataset that was generated at random.

So, the correlations that you will find in this dataset are there by pure chance and

the same is true for real financial data.

A lot of the correlations that we see are there by pure chance and

some of them are therefore, surprisingly long time and make you believe that

you've figured out how particular stocks respond to the market.

The problem is if the correlation is there by pure chance,

it will also stop by pure chance at some point.

And at that point, if you've been following that strategy,

you may end up losing a lot of money.

Now the final point is that emotions aren't always bad and

emotions can be quite accurate at times, as well.

It actually depends on the market behavior itself.

So let's say, you have a time in the market where the markets

are relatively quiet not much as happening.

In these times, your reason and your emotion tend to align quite a bit.

So the way you respond to the market emotionally,

you might be pretty much in line with what reason tells you.

However, when markets become volatile, a lot of things are happening.

Lots of fluctuations, then your emotions and

reasons start to diverge and you need to be aware of that.

So, the quiet market periods might make you believe that your emotions

are actually surprisingly good in predicting markets and

causing you to make the right decisions.

But the reason is probably, because the market is quiet and

your emotions kind of tell the same story as your reason might.

But as soon as the markets become volatile, that might change.

And now, your emotions are really bad for your investment decisions and

you should no longer follow them.

This brings us to the end of the lesson on emotion and decision-making.

Hopefully, by now, you have developed a basic understanding of

how emotions influence our financial decisions and

how that is translated into portfolio performance.

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