In my book Avantage Bourse, I introduced an equilateral triangle representing the three facets an investor must understand and master to succeed in the stock market:
Fundamental analysis (all financial ratios, understanding and analyzing financial statements, valuing a business);
Investment strategy (the way one invests, one’s investment philosophy); and
Investment psychology and the many psychological biases associated with it.
In my view, if one dedicates the necessary time and effort, the first two areas are relatively “easy” to master. Anyone can learn to analyze a company’s balance sheet, calculate growth rates, or understand a business model.
The third area—psychology—is, in my opinion, by far the most difficult to master. Even the most seasoned investors are not immune to making mistakes for psychological reasons.
Here are the four biases we discussed during the presentation. I chose them because they are widespread and particularly relevant in today’s market environment:
1. Anchoring
Here is a theoretical example that I have often observed in real life. An investor bought shares of company XYZ at $100. Six months later, the stock is worth $25. Another investor buys the same stock after this steep decline, at $25 per share. Six months later, the stock has rebounded to $50.
How do the two investors feel about XYZ?
The first investor is likely discouraged and no longer wants to hear about XYZ—after all, they have lost 50% of their initial investment. They are probably waiting for the stock to return to their original cost of $100 so they can sell.
The second investor is proud of their investment, as the stock quickly doubled after their initial purchase. They like XYZ a lot and regret not having bought more.
And yet, don’t both shareholders own the exact same company—with the same balance sheet, the same historical performance, the same management team, and the same long-term prospects?
The only difference lies in their initial cost basis, which radically shapes their perception of the stock! In reality, they should evaluate the company in the same way, based solely on its long-term outlook.
2. The tendency to overestimate one’s abilities, or the Dunning–Kruger effect
This bias is worth examining closely, as I believe it is particularly widespread today in what I would describe as a “speculative” stock market environment.
We all know the anecdote about how every driver considers themselves better than average. I would say the same is true for investors. The Dunning–Kruger effect is also referred to as overconfidence bias.
A beginner tends to overestimate their skills. That is true in many fields, but perhaps even more so in investing. This overconfidence translates into behaviors that I consider dangerous:
• Believing one can significantly outperform the indices or the best investors;
• Believing one can get rich quickly in the stock market;
• Believing one can identify the next great stock market stars;
• Favoring small-cap or early-stage companies;
• Investing on margin (or using options);
• Believing the principles of diversification do not apply to them;
• Believing one can predict market movements.
3. The tendency to conform
One thing I’ve noticed lately is that the major technology companies all seem to be launching similarly massive investments in AI. The only one that seems to be taking a different path is Apple. The institutional pressure on these companies to invest in AI is enormous—they fear missing out, and it is far more reassuring to copy others than to go it alone.
A similar phenomenon is occurring, in my view, among investors today. Many feel compelled to participate in the wave lifting most AI-related stocks.
4. The bias created by envy
It is unhealthy and dangerous to envy a neighbor who claims to be “making a fortune in the stock market.” These days, it is common to hear investors boast about exceptional returns over the past few months. But is that a reason to follow them and take on the same risks?
To guard against psychological biases, it is essential to understand them and to be able to identify them both in others and in oneself. As Socrates is believed to have said, “Know thyself.” This is especially important in investing.
Philippe Le Blanc, CFA, MBA
Chief Investment Officer at COTE 100
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This article is also published on 
(in French)
