Behavioural Finance

I'm an advocate of Behavioral Finance, the study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets. I think it's even more important then hard analysis.

The most important principle in this field, in my opinion, is availability bias, a major error in which people assess the importance of an event by the ease the event can be brought to mind. In this way, recent news are considered very important, because they are vividly present in our memory, seeming to us something specially important.

The main consequence of this bias is overreaction to recent news, leading past losers to become underpriced and past winners to become overpriced. That's exactly what happened to Cielo and Redecard some weeks ago:

Asset	26/jan	09/fev	Down	18/fev	Up
CIEL3	12,95	11,05	-14,7%	13,25	19,9%
RDCD3	21,1	18,65	-11,6%	21,08	13,0%

In a few days, we had great fluctuations in stocks prices. Why? Has something fundamental changed in both companies in so a short time? No, I think the main reason goes something like that:

• In the end of January we had some news and analysts saying that competition in credit card sector was to increase, leading to margin deterioration, blah, blah. So for people this news was readily available, everybody forgotten about the excellent margins, the oligopoly market, the real potential growth in this sector, a good yield... and everybody was selling off...
• In the beginning of February, with the earnings release, that was not so disastrous as analysts had been saying, news about these companies changed for the better, and people promptly forgotten the old news and was capable of remembering just this recent ones. Nobody now seemed to care about the real danger of increase in competition, leading stocks to sour up.

So it seems clearly that usually emotion control pays an important roll in investments and the intelligent investor should be aware of this biases.