Celina Jade
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Celina Jade in Markets at a glance,

We’re not smart enough to spot a coming stock-market crash

The psychology of money and investing is infuriating. Economists assume we’re rational beings, that we constantly evaluate cost and value to maximize utility. But too often we realize too late that the sort of thinking that once helped us survive a prehistoric moment of danger — when we were prey as much as hunter — doesn’t do much good when the danger is modern and longer term.

One problem investors face is the concept of the “anchor” price, first described by Daniel Kahneman and Amos Tversky. Regardless of the value of a share of stock, we tend to believe that value must be close to the only bit of information many of us have — the current price. This anchoring effect makes it easier to justify paying a wildly inflated price for a company that is operating at a loss or for a market that is hugely overvalued by any objective measure.

Another common fallacy investors face is herding, or the tendency to use the actions of others as a measure of sensible behavior. Fads, fashion, and stock-market bubbles are three examples of this mindset. When investors lose the sort of hard-nosed skepticism and difference of opinion that marks a healthy market, it becomes fashionable, and nearly unavoidable, for too many investors to buy too many stocks that have too little going for them.

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