What do the NSE Series – EQ, BE, BL, BT, GC, IL & IQ Mean ?
The recent past has seen the development of a new field in investing that blends economic decision making with psychology in order to understand individual as well as collective financial behaviour.
Investors and traders alike get lost in myriad illusions created by the mind that is a big stumbling block for making wise investing or trading decisions.
Here is another way “framing” impedes decisions that we seldom recognise.
Investors are not as much “risk averse” as they are “loss averse”.
Here is a Desi version of classic example which presented to two groups of people.
Group I choice set
You have Rs.1,000 in your pocket and need to choose between one of these two investing options
Option 1: A sure shot gain of Rs.500
Option 2: A 50% chance to double the money and a 50% chance of making no profits
What would you choose?
Group II choice set
You have Rs.1,000 in your pocket and need to choose between one of these two investing options
Option 1: A sure shot loss of Rs.500
Option 2: A 50% chance of losing the Rs.1,000 capital and a 50% chance of losing nothing!
Hmm! In this experiments we found that 84% in Group I chose option 1 whereas in Group II, a good 69% chose option 2 !!
Know why the groups chose those options the way they did? It had to do with the way the options were posed to them. Group II participants had a sure shot loss staring at them as one option whereas the other option presented them an opportunity though half a chance to walk away with losing nothing.
Of course, the knowledgeable among you would have figured out that there is nothing to choose between the two options, as they are the same.
Hence, as long as the Sensex is climbing 400 points every month, a bullish trader will stomach a 100-point fall during a week and see it as a money-making opportunity. But when the Sensex is in a downtrend, even a 100-point rally during a week does not enthuse the traders enough!
In fact, empirical studies done in the USA prove the following: “Positive emotional value of a gain is only one-half to one-third of the negative emotional value of an dollar equivalent loss. For example, a $100 loss causes emotional pain two to three times the emotional pleasure of a $100 gain.” This theory is called “Prospect Theory”?
Most people feel more pain for losing Rs.100 than they feel happiness when they make Rs.100.
Which portfolio would you prefer?
Portfolio A has Rs.1,000 worth of one stock that appreciates by 10% and Rs.1,000 worth of another stock that declines by 15%.
Or
Portfolio B has Rs.1,000 worth of one stock that stays flat and Rs.1,000 worth of another stock that declines by 5%.
There are similar studies done that demonstrate people prefer portfolio B to portfolio A.
Why?
Portfolio A has one stock that declines by 15% whereas the maximum decline of stock in Portfolio B is 5%. The mind ignores the fact that the other stock in Portfolio A appreciates by 10%.
Hence, most people prefer Portfolio B to Portfolio A though both the portfolios lose the same.
Thank you for the Patience reading…!!!
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