Why Do We Fall in Love with Our Investments?
March 9, 2023 (Investorideas.com Newswire) Societies that foster free-market economies, like our own, tend to place a high value on the right of the individual to pursue his own financial freedom and not, simply, live as a victim of his life circumstances. When it comes to trading assets or CFDs in the financial markets, there are also the practical possibilities of improving one's material conditions, of climbing a step up on the ladder of class and distinction, of creating life opportunities for one's children. These are some of the reasons people find it appealing to trade with financial assets and CFDs.
An interesting fact economists have long noted is that people have a tendency to form emotional biases toward or against financial instruments. As a result, they often treat them irrationally, rather than view them with the dispassion that would befit a mere financial tool. One example of this is cognitive dissonance, when an individual ignores inconvenient information. There is also confirmation bias, which inclines people to emphasize information that seems to confirm their pre-existing beliefs.
A third example, which will be the focus of this article, is called the endowment effect. This happens when people place an unreasonably high value on an asset just because they own it, or have established a financial contract in relation to it. Imagine someone who inherits company shares from a beloved, deceased family member. It's likely he won't view those shares as dispassionately as he would a wad of cash he found lying in the street, and the reason is that those shares carry emotional significance for him.
Our topic has a lot in common with this, although there are dissimilarities too. Let's dive into the most important explanations of this phenomenon, bearing in mind we are trying to enhance and improve the way we relate to financial instruments and CFDs.
Participants in a study were asked to evaluate a coffee mug and mention a price they would be willing to pay for it. Each of them was then given a mug as a gift. The researchers conducting the study offered them the chance to sell their mugs or to trade them for another object of equal value (in this case, it was pens). It was found that the participants would only part with their mugs if they were offered about twice their original evaluation of it.
In another study, workers were asked to assess how hard they would be willing to work in order to merit a bonus in pay. Afterwards, they were asked how much work they'd put in to retain a bonus they'd already received. According to the responses, people would put in more effort in the second case than the first, even though the sums of money in question were exactly the same.
One theory to explain this is quite straightforward: People dislike losing things. According to this explanation, called loss aversion, out tendency to overvalue what we own is not so much a personal or emotional bias, as an instinct to protect ourselves against loss.
Theory number two is called psychological inertia, and it says that, when you want to buy your friend's mug, neither of you knows precisely how much it's worth. Rather, you both only know the general price range in which it might fall. As a result, your friend will only feel motivated to sell it if he sees he will make a definite financial gain. This explanation doesn't take account of any personal feelings of love or attachment you might have towards your CFDs or other financial assets
The final theory is called "Psychological Ownership Theory". This intriguing explanation delves into the psychological bases of you biases. Proponents of this theory maintain that, when you buy financial assets, CFDs, or vases for your living room, your new purchase becomes associated with your concept of yourself. As a result, the vase has become more than a vase: In your mind, it is now the expression of a certain aspect of you. When the vase is threatened, you may feel that, in a certain way, you yourself are threatened.
We suggest you use this article as a springboard for further reading, because this is a fascinating and widely researched topic. At the least, we can see that, once our money is on the line, we are unlikely to approach financial instruments like CFDs with the objectivity of a scientist. It's even possible we will think or act irrationally in order to justify or protect our purchase, ignoring the dictates of logic and reason.
This is why it's advised that you develop a trading strategy, based on a generous array of reliable reading materials, and strictly adhere to it. This way, you may, to some extent, resist the persuasive power of the endowment effect.
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