The Kahneman Effect: Thinking Smarter, Investing Wiser

The Indian equity market is currently thriving, reaching all-time highs despite recent bouts of volatility. However, many investors find that their portfolios do not reflect this success. Besides investment, even in trading it is well-documented and researched that more than 90 per cent of the traders lose money, largely due to the human tendency to feel loss more intensely than gain. This insight, pioneered by the late Daniel Kahneman, revolutionised our understanding of decision-making in finance. He recently died at the age of 90.
[EasyDNNnews:PaidContentStart]

We pay tribute to the groundbreaking work of Daniel Kahneman, a towering figure in behavioural economics. Professor Kahneman, alongside his collaborator Amos Tversky, forever changed our understanding of how humans make decisions, particularly when it comes to money. Prior to Kahneman’s work, traditional finance relied on the concept of Homo economicus –a rational actor making perfectly logical choices. However, Kahneman’s research revealed the true human: a complex creature prone to biases and emotions that significantly impact financial decisions. 

His most celebrated work, the prospect theory, delves into how we perceive gains and losses. We tend to feel losses more deeply than gains, leading to risk aversion when protecting our money but risk-seeking behaviour when trying to recoup losses. This explains why investors might hold on to a losing stock for too long, hoping to avoid the pain of selling at a loss, or chase risky bets to regain what they have lost. 

Kahneman also identified cognitive biases that distort our thinking. Overconfidence, for instance, can lead investors to overestimate their knowledge and invest in unsuitable assets. Anchoring bias, meanwhile, makes us fixate on irrelevant information, like a stock’s initial price, hindering objective evaluation. By understanding these biases, investors can become more aware of their own emotional and cognitive shortcomings. Kahneman’s work reminds us that we are not emotionless robots. 

By acknowledging our biases and employing strategies to mitigate them, we can become better financial decision-makers, navigating market volatility with greater clarity and achieving our investment goals. It is easier said than done. After all, as Kahneman himself said, reading his seminal work, Thinking Fast and Slow, won’t help individuals think better just as writing it didn’t make him a more effective thinker. 

Throughout our articles, we aim to echo the insights gleaned from Kahneman’s research. This issue is no exception, offering various narratives to enlighten readers. For instance, we delve into the history of bubbles and offer guidance on avoiding herd mentality. Additionally, we present a compilation of companies trading at unjustifiable valuations relative to their financial performance. Our cover story scrutinises the performance of the information technology (IT) sector, a key player in frontline indices alongside NASDAQ. 

Despite moving in sync historically, we observe a recent divergence between Indian IT and NASDAQ. Our analysis explores the reasons behind this disparity and forecasts the trajectory of Indian IT companies. In closing, we draw upon Kahneman’s wisdom: “Knowing is not enough; we must apply. Willing is not enough; we must do.” Let’s translate knowledge into action, making informed decisions to safeguard our financial future. So, invest wisely and keep your emotions aside when it comes to financial matters.
 

RAJESH V PADODE
Managing Director & Editor

[EasyDNNnews:PaidContentEnd] [EasyDNNnews:UnPaidContentStart]

[EasyDNNnews:UnPaidContentEnd]