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Investor Behavior: The Psychology of Financial Planning and Investing by Douglas Brown

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CHAPTER 25

The Psychology of Trading and Investing

Julia Pitters

Assistant Professor of Psychology, Webster University, Vienna

Thomas Oberlechner

Chief Science Officer, iMATCHATIVE

INTRODUCTION

Then up he got with a light heart, free from all his troubles, and walked on until he reached his mother's house, and told her how very easy the road to good luck was.

Grimm and Grimm (2012, p. 12)

This quote from a Grimm fairy tale describes the experience of Hans in Luck after he had traded a piece of gold the size of his head for a horse, the horse for a cow, the cow for a pig, the pig for a goose, and the goose for a grindstone that finally fell into the water. This series of transactions shows how trading behavior may objectively be unsuccessful but subjectively still be rewarding and valuable. The traditional finance approach, which is based on rational expectations and profit maximization, fails to provide an explanation for this behavior because it is not economically rational. However, not only in fairy tales but also in real world markets seemingly irrational trading decisions take place, as the recent financial crises have amply demonstrated around the globe.

New approaches are needed to describe, explain, and predict trading and investing decisions. These approaches should not only take into account the dynamics between different market forces and human actors but also consider the plethora of nonrational aspects that occur when humans form decisions. This chapter explores the ...

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