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Behavioral Finance Principles

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Overconfidence Bias

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Overconfidence bias is a well-established bias where a person's subjective confidence in their judgments is reliably greater than their objective accuracy, especially when confidence is relatively high.

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Anchoring

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Anchoring refers to the cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered when making decisions.

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Framing Effect

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The framing effect is a cognitive bias where people decide on options based on if the options are presented with positive or negative connotations; e.g. as a loss or as a gain.

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Confirmation Bias

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Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one's preexisting beliefs or hypotheses.

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Availability Heuristic

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The availability heuristic is a mental shortcut that relies on immediate examples that come to a person's mind when evaluating a specific topic, concept, method or decision.

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Herd Behavior

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Herd behavior describes how individuals in a group can act collectively without centralized direction. In finance, it relates to individuals copying the actions of a larger group, sometimes leading to market bubbles or crashes.

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Endowment Effect

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Endowment effect occurs when individuals value an owned item more highly simply because they own it, which is associated with a reluctance to sell or trade it.

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Mental Accounting

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Mental accounting refers to the different values people place on money, based on subjective criteria, often leading to irrational decision-making.

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Loss Aversion

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Loss aversion is a concept in behavioral finance that describes why the pain of losing is psychologically about twice as powerful as the pleasure of gaining.

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Base Rate Fallacy

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The base rate fallacy is the tendency to ignore base rate information (generic, broad information) and focus on specific information (information only pertaining to a certain case).

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Gambler's Fallacy

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The gambler's fallacy is the mistaken belief that if something happens more frequently than normal during a given period, it will happen less frequently in the future, or vice versa.

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Disposition Effect

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The disposition effect is the tendency for investors to sell assets that have increased in value, while keeping assets that have dropped in value.

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Regret Aversion

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Regret aversion is a fear of regretting poor choices, which leads to avoiding making decisions, such as the sale of an investment.

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Prospect Theory

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Developed by Daniel Kahneman and Amos Tversky, the theory describes how people choose between probabilistic alternatives that involve risk, where the probabilities of outcomes are known.

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Hindsight Bias

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Hindsight bias is the tendency to believe, after an event has occurred, that one would have predicted or expected the outcome, which is also known as the 'knew-it-all-along effect'.

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