Investor psychology has been analysed for at least 250 years. Charles MacKay wrote his book, ‘Extraordinary Popular Delusions And The Madness Of Crowds’, in 1841, describing, among other manias, the herd mentality that caused the South Sea Bubble. Since then, many academics have published financial theories based on the concept that individuals act rationally and consider all available information in the decision-making process. But real life frequently demonstrates that the behavior of equitymarkets is irrational and unpredictable. A field known as “behavioural finance” has evolved over the years attempting to explain how emotions influence investors and their decision-making process. Studying human psychology helps predict the general direction of financialmarkets as well as many stockmarket bubbles and crashes. At the height of a period of optimism, greed moves stocks higher, ignoring business fundamentals and therefore creating an overpricedmarket. At the other extreme, fear moves prices lower, ignoring obvious opportunities and creates an undervaluedmarket.
