Basic Behavioural Biases Influencing Investments

Behavioural biases are systematic patterns of deviation from rational decision‑making that arise from psychological tendencies. In the Indian context, these biases are amplified by limited financial literacy, media hype, and the prevalence of advisory channels that may not disclose conflicts of interest.

For the NISM exam, SEBI expects candidates to recognise that such biases can lead to mis‑pricing, higher turnover, and sub‑optimal risk‑adjusted returns. The syllabus frequently asks you to match a bias with its observable market outcome, such as excessive trading or holding losing stocks too long.

Remember, a bias is an internal cognitive error, not a market inefficiency caused by external factors. Exam questions often test this distinction.

• Behavioural bias – internal psychological tendency.
• Market inefficiency – external factor causing price deviation.

Four biases dominate the Indian retail segment: Overconfidence, Anchoring, Herding, and Loss Aversion (often expressed through the Disposition Effect). Each has a clear behavioural root and a measurable impact on portfolio performance.

Overconfidence leads investors to over‑estimate their ability to pick winners, resulting in higher turnover and lower risk‑adjusted returns. Anchoring causes investors to cling to a past price or index level, ignoring new information.

Herding is the tendency to follow the crowd, especially during IPO rushes or market rallies, while loss aversion makes investors reluctant to realise losses, manifesting as the Disposition Effect. SEBI’s Investor Education initiatives frequently cite these biases.

Overconfidence bias occurs when investors believe their knowledge or skill exceeds reality. In India, this is visible when traders repeatedly chase hot stocks after reading a single analyst note.

The bias leads to excessive trading, higher transaction costs, and a tendency to underestimate portfolio volatility. SEBI’s research shows that overconfident investors often under‑perform the market after accounting for costs.

Exam questions may present a scenario where an investor trades daily despite a long‑term goal. The correct identification is Overconfidence bias, not merely “high frequency trading”.

Anchoring bias is the tendency to rely heavily on an initial piece of information – the “anchor” – when making decisions. An Indian investor may fixate on the IPO price of a stock and refuse to sell even when fundamentals deteriorate.

This bias can cause delayed portfolio rebalancing and mis‑allocation of capital. The NISM syllabus highlights that anchoring often results in a mismatch between the current risk profile and the investor’s target allocation.

In exam scenarios, look for language such as “still holding the stock at twice its original price because it was once a ‘good deal’”. That points to Anchoring.

The Disposition Effect is the propensity to sell winning positions too early while holding onto losing positions too long. Indian investors often exhibit this during market corrections, preferring to lock in small gains and hoping losses will revert.

This behaviour reduces overall portfolio return because winners are trimmed prematurely and losers erode capital. The effect is quantified by comparing the proportion of realized gains to realized losses.

Exam questions may ask which bias explains “selling a stock after a 10% rise but retaining another after a 15% drop”. The answer is the Disposition Effect.

Herding occurs when investors mimic the actions of a larger group, often ignoring their own analysis. In India, this is evident during the “lottery‑like” buying of newly listed equities or during sudden market rallies driven by media hype.

Herding can inflate asset bubbles and lead to sharp corrections when sentiment reverses. SEBI monitors herding patterns to identify systemic risk, especially in mutual fund flows.

For the exam, a description such as “joined the crowd buying a mid‑cap stock after a celebrity endorsement” signals Herding bias.

Loss aversion, a core component of Prospect Theory, states that investors feel the pain of a loss more strongly than the pleasure of an equivalent gain. This leads to risk‑averse behaviour in the domain of gains and risk‑seeking behaviour in the domain of losses.

In practice, Indian investors may avoid selling a losing mutual fund unit, hoping for a rebound, while prematurely exiting a profitable position to “lock in” gains. The NISM syllabus connects loss aversion to the Disposition Effect.

Exam writers often embed loss aversion in scenario‑based questions that describe “reluctance to realise a loss”. Recognising the link to Prospect Theory earns marks.

SEBI recommends systematic investment plans (SIPs), periodic portfolio reviews, and adherence to a written investment policy statement to curb biases. Using a diversified basket reduces the impact of any single biased decision.

Behavioural coaching tools—such as pre‑trade checklists, stop‑loss orders, and performance attribution reports—help investors recognise when bias may be influencing a decision.

For the exam, candidates should match mitigation techniques with the appropriate bias. For example, a pre‑trade checklist is most effective against Overconfidence, while a written policy statement counters Anchoring.