Behavioral Finance Explains the Stock Market Bubble
- The factors that are inflating the stock market are in fact behavioral biases.
- Because biases are built into the human psyche, they won’t go away.
- This bubble could inflate for an exceedingly long time.
Are you confused and perplexed by the incredible runup in stock prices? I was too. Then it occurred to me that investor behavior is the reason, so I researched behavioral finance and discovered explanations for every pump that is inflating the stock market.
The differences between traditional finance and behavioral finance
There’s a big difference between the way I was educated to think about capital markets and the way that behavioral scientists look at them, Behavioral scientists view investors as “normal”, which means they may be, and sometimes are, irrational. Remember Alan Greenspan’s “irrational exuberance.”
Here are the ways that traditional finance differs from behavioral finance:
Behavioral finance explains all
Investor behavior is inflating the stock market. The rationalizations for high prices are “normal”, not rational. Here are the behavioral finance biases that explain the current stock market bubble. Biases are built into the human psyche. They never go away. This bubble might inflate for a long time.
Now that you know, do you understand? Riding the bubble can be very lucrative but be sure to get off the roller-coaster before the inevitable bubble bursts. This takes foresight and discipline, which may be in short supply.