Why we often act irrationally on the stock market – and the role of psychology

Loss aversion describes the tendency for losses to have a stronger emotional impact than gains of the same amount. As a result, investors often hold on to losing positions for too long while taking profits too early. This is contrary to the well-known investment principle to 'limit losses and let profits run'.

Confirmation bias – hearing what we want to hear

People actively seek out information that confirms their existing beliefs while disregarding opposing views. For example, investors who are convinced of a particular stock tend to focus on positive analyses and ignore critical assessments – often a recipe for misjudgment.

Attention bias – seeing what we want to see

Investors tend to pay greater attention to positive news about their investments while filtering out negative information. This selective perception can foster excessive confidence and distort risk assessment.

Overconfidence – when overestimating your abilities erodes returns

Many believe they can outperform the market, but unnecessary trading and excessive risk-taking often undermine returns. This is particularly evident in tactical asset allocation, where frequent portfolio rebalancing rarely generate added real value.

Availability bias – what is top of mind feels more likely

We often to overestimate the likelihood of events that are particularly salient or recent. After widespread reporting of a market crash, another one may seem more likely – even if underlying fundamentals remain unchanged.

Anchoring – When the first number sets the frame

Anchoring describes our tendency to fixate on initial information. A stock that falls from £100 to £70 may appears attractive simply because of its previous price – even if the company’s fundamentals have deteriorated. Expectations also act as anchors: if earnings fall short of forecasts, share price may decline even when results are objectively strong.

Conclusion: Understanding yourself is key

Financial markets are not a game of chess; they are complex systems in which psychological factors play a significant role. Investors who understand their own cognitive biases can learn to manage them - and ultimately make better investment decisions.

Perhaps the most important investment insight is this: don't just understand the market – understand yourself.

One way to mitigate behavioural biases is through investing in funds with a quantitative, rules-based approach. The Alturis Volatility (ISIN: DE000A3C91X1, AK CS) is one such fund. Its strategy focuses on harvesting volatility premiums, offering investors attractive returns by capitalising on the spread between implied and realised market volatility.
In calmer market environments, this approach can generate stable income streams. In addition, such strategies can enable portfolio diversification and reduce overall risk through asymmetric return profiles.