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Stocks 407: Psychology and Investing

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1.
What does representativeness lead to?
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Giving too much weight to recent performance. Representativeness is a mental shortcut that causes investors to give too much weight to recent evidence--such as short-term performance numbers--and too little weight to evidence from the more distant past. For instance, a look at a companys profit trends over the past six years is likely to yield more insight than looking at that companys stock performance over the past six months.
2.
If you find yourself habitually buying shares of a company that has treated you well in the past, even when the data suggest it would be unwise, you could be operating under confirmation bias.
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True. Though its not always a bad thing, investing against the reality of the company can sometimes be detrimental.
3.
The framing effect can lead you to treat buying decisions in relative terms.
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True. This effect can affect the choices you make when you buy investments.
4.
An example of sunk costs is _______.
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Holding on to a stock for too long because you have put a lot of money into it. When we have "sunk" money into something, we may be reluctant to let go of it when it turns into a loser.
5.
What does overconfidence in investing often lead to?
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Rapid trading. Overconfident investors trade more rapidly because they think they know more than those on the opposite end of the trade.
6.
A way to describe the psychological concept of loss aversion is this: strongly preferring to avoid losses over acquiring gains.
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True. This behavior can in some cases cause you to lose money.
7.
In investing, self-handicapping might be considered the opposite of _______.
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Overconfidence. Self-handicapping involves looking for excuses beforehand to explain why something might not work. If it indeed does not work, we have handicapped ourselves.
8.
The practice of herding refers to _______.
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Going along with the crowd. This is the practice of buying and selling based on the fact that it is popular to do so at the time.
9.
Mental accounting refers to _______.
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Keeping our money in different buckets for different purposes. While this practice is often beneficial, it can sometimes lead to wasteful spending depending on how we view those buckets.
10.
What does anchoring often lead to?
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An unwillingness to part with laggard investments. Investors often cling to investments in order to wait for a point at which they will break even, even if the underlying business has fundamentally changed for the worse.