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Regardless of what we would like to believe, we rarely are the rational/ efficient/ objective investors assumed by most theories. In fact, the list of 'simplifying' assumptions about our behavior in standard economic models is so stultifying, it makes me wonder which species the author's writing about.

In reality, our investing chatter is full of emotionally charged terms like 'bull run', 'bear rout', 'hot tip', 'pump and dump', etc. Because they portray our in-market behavior so much better than that stuffed shirt 'homo economicus'.

The relatively new field of Behavioral Finance goes a long way toward recognizing our real-life behavior, thus helping us better understand how we really behave as investors.

Here are just a few of the key findings:
Overconfidence
- We overestimate our knowledge of an investment, underestimate its risks, and exaggerate our ability to control its outcomes.
- Not realizing that we don't know enough, we take bad bets.
- Overconfidence drives excessive trading frequency

“It's not what a man don't know that makes him a fool, but what he does know that ain't so.”

Boys Will be Boys: Gender, Overconfidence, and Common Stock Investment by Brad M. Barber and Terrance Odean
http://www.mitpressjournals.org/doi/abs/10.1162/003355301556...

Endowment effect
- We value things we own more than those we don't.
- We hang on to inherited assets regardless of their fit in our investment profiles
- a.k.a. 'status quo bias': we demand more to give up something than we're prepared to pay for it

Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias, by Daniel Kahneman, Jack L. Knetsch and Richard H. Thaler
http://www.jstor.org/pss/1942711

Prospect theory

- We are less willing to gamble with profits than with losses
- We sell quickly when we're winning, but avoid selling if we're losing

Prospect Theory: An Analysis of Decision under Risk, by Daniel Kahneman and Amos Tversky
http://www.jstor.org/pss/1914185

If you're not into slogging through original papers, probably the easiest book to read on the subject is “Why smart people make big money mistakes... and how to correct them” by Gary Belsky and Thomas Gilovich
http://www.amazon.com/Smart-People-Money-Mistakes-Correct/dp...
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