Warning signs for investors: These cognitive biases may lead to gambling

Cognitive biases may lead investors to choose risky investment options which may turn into a gamble and result in huge losses. Know what these biases are to ensure that you take wise investment decisions.

STAGE 1: REASON FOR INVESTING

Sensation-seeking: This personality trait makes people look for exciting, intense, new experiences, typical of gamblers. This usually translates to different, high-risk investments like futures & options, day trading or cryptos.Greed, or desire for quick, big gains: This need for ‘making a killing’ drives most gamblers, as well as investors with no knowledge of products, or those in financial distress.

Social proofing: This is a psychological phenomenon where unsure investors mimic those who have had good experiences in a particular type of investment. So when they see people making huge gains in crypto or penny stocks, they will follow suit.

Also read | Are you investing or gambling? How you can avoid losing money to risky investment choices

STAGE 2: PRODUCT SELECTION

Herd mentality: Investor segments with no knowledge of investing and low socio-economic profiles typically follow what the masses are doing. If you don’t know why or how you are investing, it’s a gamble.

Survivorship bias: This bias makes people invest by focusing only on selective information put out in the public. So when friends or influencers declare the fortune made via day trading or derivatives without mentioning their losses, people rush to make poor investing choices.

Also read | This type of investors are likely to be drawn to highly risky investments

STAGE 3: EARLY RETURNS (in case of profits)

Illusion of control bias: A bias common to gamblers, this makes investors believe they can control the outcome of an investment when, in fact, they can’t. This leads them to invest more in an instrument that they may know nothing about, and result in losses.

Optimism bias: This makes a person overestimate the likelihood of positive outcomes and underestimate the possibility of negative results. So early profits give the illusion of ability and belief that they will always win.

STAGE 4: MID-STAGE RETURNS (massive losses)

Revenge trading: This is a trait that makes people dig a deeper investing grave for themselves in an effort to redeem their losses. Angered by a loss, they invest more as a way to avenge it, almost always ending in a bigger loss.

Emotional instability: This trait is typical of gamblers who are impacted very strongly by even small wins or losses. In investment, it translates to irrational decisions and imminent large losses.

STAGE 5: END STAGE (compounding losses)

Loss aversion bias: This bias makes people averse to losses because losing a small amount affects them more deeply than earning a bigger amount. To redeem the financial loss and fallen pride, they keep investing in a losing stock, putting good money after the bad.

Gambler’s fallacy: This bias, very visible in gamblers, makes an investor believe that a random outcome is more likely because a series of opposite events has happened. So if they have been incurring losses in a stock for a long time, they are convinced that it will make a comeback soon.