In week one, two related topics are put under discussion. In this week the efficient market hypothesis is analyzed for identifying the market factors influencing the decision making. The application of behavioral finance in taking decisions in the inefficient market is also analyzed. The behavioral factors involved in the investment market decisions are discussed here for identifying the importance of behavioral finance. “Behavioural finance is the study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets.” (Sewell, 2008).
The first topic is related to the efficient market hypothesis. In this topic, the features of the efficient market hypothesis are discussed to compare it with behavioral finance.
Through this topic, I understood that in EMH the available information in the market influences the market prices. “According to the EMH, “stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices.” (Efficient market hypothesis- EHM, 2009).
An efficient market consists of a large number of rational investors, actively participating in the competition and the information in the market is easily accessible for all of the investors. The free availability of information to all of the investors on a real-time basis facilitates the investors to make use of this information for taking adequate decisions in the investment market. Thus the actual prices of individual securities in the market should reflect the effects of information relating to events that have already occurred or are expected to occur shortly.
The second topic is related to behavioral finance. The question discussed is “In what ways can behavioral finance be used to find and exploit inefficiencies in the market?” in this topic I discussed the implications of behavioral finance in the inefficient market system.
Behavioral finance is based on the concept that market inefficiencies can be identified and effectively exploited for making accurate predictions on future investment market movements. It is an alternative view of the efficient market hypothesis or EMH.
“Behavioural finance is the study of investors’ psychology while making financial decisions. Investors fall prey to their own and sometimes others’ mistakes due to the use of emotions in financial decision-making.” (Velma, 2004).
The discussion revealed that several behavioral factors influence the decisions. They are overconfidence, anchoring, availability bias, errors of preferences, and loss aversion. “Behavioural Finance has the potential to be a valuable supplement to the traditional financial theories in making investment decisions.” (Venkat, 2005).
This week’s activities helped me greatly to empower the knowledge relating to the different market systems and their impact on the investment decisions of the investors. The opportunities in the inefficient market system can be effectively exploited through applying behavioral finance. The suggestions for investors for successful investment in the inefficient market are given below; ”
- “Accept that investing is a probabilistic art.
- Recognize and avoid the circumstances leading to undue confidence.
- Deliberately seek out the contrary view.
- Have a written plan for each position, especially the exit.” (Practical behavioral finance n.d.).
The topic of efficient market systems discussed in the week is not new to me as I am familiar with the efficient market system. But the topic of behavioral finance is new to me. In the week I attend six days in the class. My participation in the class helped me greatly to understand the different aspects of leadership in organization management. It helped me to enhance the learning process in the investment market field. The research paper on the topic is successful as the data collection seems to be lesser effort.
References
- Efficient market hypothesis- EHM: what does efficient market hypothesis – EHM mean? 2009, Investopedia: A Forbes Digital Company.
- Sewell, M 2008, Behavioural finance: introduction. Web.
- Velma, V 2004, Behavioural finance as investment concept: can you explain behavioural finance is and how it works, Business Line.
- Venkat, S 2005, Behavioural finance: challenges, Indianmba.com.