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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.
A disadvantage of "anchoring" behavior in investing is that you might hold onto an investment longer than you should, given the fundamentals of the company behind it.
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True. As an investor, you might stick with an investment in order to wait for a point at which it will be "worth it" to you, which might lead to a loss on it.
3.
Confirmation bias is the practice of _______.
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Giving preference to information that supports what we already believe. This practice can sometimes limit our success with investing by shutting out other opportunities.
4.
What is a good way as an investor to avoid falling prey to the framing effect?
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Consider the total return of your investments. Seeing your choice in terms of the total return can help you avoid framing it in relative terms, which can be costly.
5.
The sunk costs fallacy refers to _______.
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Being unable to ignore the sunk costs of an investment. Being unable to ignore these costs could lead to holding onto the investment well past the time to sell it.
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.
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.
8.
Self-handicapping bias occurs when we try to explain any possible future poor performance with a reason that may or may not be true.
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True. In other words, its like making excuses beforehand.
9.
Mental accounting is a psychological practice that refers to keeping our investments in good condition.
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False. Mental accounting really means putting our money in different buckets for different purposes. Its not always harmful, but sometimes it can inadvertently lead to wasteful spending.
10.
Investors who exhibit "herding" behavior tend to think that other investors have more information than they do.
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True. Herding refers to investing along with the crowd. This usually entails believing that others have information that you dont.