Cognitive biases in young adults while investing in stock market

Abstract

This research investigates the prevalence and impact of cognitive biases on young adults' (18-25) money-making decisions in the stock market. Employing a mixed-methods approach, encompassing a questionnaire, a stock market simulation game, and one-on-one interviews, the study tested five common biases: Confirmation, Anchoring, Framing, Hindsight, and Overconfidence. The game of simulation, comprising seven levels of trading virtual stocks with specially updated news, generated behavioral information, while the questionnaire elicited attitudes and risk profiles. Confirmation bias was the most common among the findings, especially among those who had had earlier positive experiences in the market, resulting in repetitive investment in well-known stocks in spite of adverse signals. Anchoring bias resulted in the participants being anchored on initial stock prices, which impeded adaptation to changes in the market. Framing bias had a great impact on patterns of trading depending on the positive or negative framing of information. Overconfidence bias, which was more evident among male participants and seasoned investors, led to overtrading and risk-taking. Hindsight bias caused participants to think that market results could have been foreseen, leading to overconfidence. Economic analysis of the simulated data revealed that such biases caused suboptimal diversification, slow exits from losing positions, irrational reactions to framed information, overtrading, and asymmetric learning curves. Interestingly, initial levels exhibited Confirmation and Anchoring bias dominance, while subsequent levels experienced a rise in Overconfidence and Hindsight biases, which implies that experience per se does not reduce but could even accentuate some of the biases. The research points to the urgent need for education and interventions to enable young investors to recognize and overcome these psychological pitfalls to promote more sensible financial decision-making.