Behavioural Finance

Classical economics assumes investors are rational — they process information objectively, weigh probabilities correctly, and make decisions that maximise their long-term wealth. Behavioural finance, built on the work of Daniel Kahneman and Amos Tversky, shows this is comprehensively wrong. Understanding the specific ways your brain systematically misleads you is one of the most practically useful things an investor can learn.

Loss aversion — losses hurt twice as much

Kahneman's most important finding: the pain of losing £100 is roughly twice as powerful as the pleasure of gaining £100. This asymmetry is hardwired — it made evolutionary sense to avoid losses more than seek gains. In investing, it produces terrible outcomes. Investors hold losing positions far too long (refusing to "realise" the loss) and sell winners too early (locking in gains before they can be lost).

Confirmation bias — only hearing what you want

Once you own a stock, you unconsciously seek out information that confirms your investment thesis and dismiss or downweight information that challenges it. You read bullish articles about the company and skip the bearish ones. You interpret ambiguous news as good. This is why investors often hold far too long after the fundamental case has deteriorated — their brain has constructed a narrative that filters out the warning signs.

Anchoring — the tyranny of the purchase price

Investors anchor to the price they paid for a stock as if it's meaningful. "I can't sell, I'm down 30%" — as if the stock knows what you paid for it. The purchase price is irrelevant to the stock's future prospects. The only relevant question: given what you know now, is this the best use of this capital going forward? If you'd never owned it, would you buy it today? If the answer is no, the anchor is preventing a rational decision.

FOMO and herding — buying what's already up

Fear of Missing Out drives investors to buy assets after they've already risen substantially — chasing performance rather than value. This is the mechanism behind every bubble. The assets that appear "most exciting" (GameStop, NFTs, certain meme coins) are almost always the ones where FOMO has already done most of the damage. By the time something is dominating the news and your social feed, the people who made money bought before the headlines.