The following is a glossary of technical terms related to the discussion of how thinking affects investment decisions.
For more information about these terms, just look for a link (for example,) showing the number of the section where that term is discussed. Just click on the link to jump to the exact place in the text where that particular term is explained.
Anchor: A specific piece of information, used as the basis for making a decision.
Anchoring: Making a decision that relies too much upon one specific piece of information (an anchor).
Behavioral economics: The branch of economics that studies how emotional, cognitive, and social factors influence economic decisions.
Bounded rationality: Our inability to make the best-possible decisions because, as human beings, we are limited by (1) the amount of information that is available to us; (2) our thinking ability; (3) having to make decisions in a finite amount of time.
Cognitive biases: Distorted patterns of irrational thinking that lead to poor judgment. Where heuristics are often useful to our lives, cognitive biases are almost always harmful in some way, as they blind us to the reality of the problem at hand.
Cognitive dissonance: Mental discomfort created by holding two conflicting ideas in our mind at the same time. Cognitive dissonance is most pronounced when our actions do not match our beliefs.
Confirmation bias: Remembering and interpreting information in a way that confirms to what we already believe. The most important characteristic of confirmation bias is that the stronger the belief, the stronger the bias.
Disposition effect: The tendency to wait too long to take losses or to move too quickly to realize gains.
Endowment affect: When we own something, the tendency to place a higher value on it than we would if we didn't own it. Same as Same as ownership bias.
False analogy to the physical world: Assuming, unconsciously, that prices in the stock market change in such a way as to follow the familiar laws of physics.
Heuristics: Mental shortcuts that underlie our decision-making processes. Some heuristics are innate, hard-wired into our brain when we are born. Others are based on our experience and are learned as we mature.
Loss aversion: The tendency to make decisions primarily to avoid losses, because the satisfaction that comes from avoiding a loss is much stronger than the satisfaction that comes from acquiring a similar gain.
Ownership bias: Same as endowment affect.
Representation bias: Assuming that the stock market is influenced by predictable forces, capable of acting in ways that are familiar to us.
Sunk cost: Money that has been spent and can never be recovered.
Sunk cost effect: Making a financial decision based upon a sunk cost. Being influenced by an emotional reaction caused by thinking about money that has already been spent and can never be recovered.
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