Behavioral Finance How Psychological Factors can Influence the Stock Market

Behavioral finance proposes that psychological influences and biases affect the financial behaviors of investors and financial practitioners.

Moreover, influences and biases can be the source for an explanation of all types of market anomalies and specifically market anomalies in the stock market, such as severe rises or falls in stock price.

Behavioral finance can be analyzed from a variety of perspectives. Stock market returns are one area of finance where psychological behaviors are often assumed to influence market outcomes and returns but there are also many different angles for observation. The purpose of the classification of behavioral finance is to help understand why people make certain financial choices and how those choices can affect markets. Within behavioral finance, it is assumed that financial participants are not perfectly rational and self-controlled but rather psychologically influential with somewhat normal and self-controlling tendencies.

One of the key aspects of behavioral finance studies is the influence of biases. Biases can occur for a variety of reasons. Biases can usually be classified into one of five key concepts. Understanding and classifying different types of behavioral finance biases can be very important when narrowing in on the study or analysis of industry or sector outcomes and results.

The understanding and usage of behavioral finance biases are applied to stock and other trading market movements daily. Broadly, behavioral finance theories have also been used to provide clearer explanations of substantial market anomalies like bubbles and deep recessions.