Glossary: Behavioral Finance Terms
Difficulty: Beginner Published: 2025-12-28
Introduction
This glossary defines 30 behavioral finance terms with one-sentence definitions focused on investment application. Updated quarterly as new research emerges.
Terms
Anchoring Bias: Tendency to rely too heavily on first piece of information encountered (the anchor) when making decisions, such as fixating on purchase price when evaluating whether to sell.
Availability Heuristic: Tendency to overweight readily available information (recent news, vivid events) when estimating probabilities, leading to recency bias.
Confirmation Bias: Tendency to search for, interpret, and recall information that confirms pre-existing beliefs while dismissing contradictory evidence.
Decision Fatigue: Deteriorating quality of decisions after long session of decision-making, often causing investors to default to status quo or make impulsive choices late in trading day.
Disposition Effect: Tendency to sell winning investments too early (to lock in gains) and hold losing investments too long (to avoid realizing losses).
Emotional Accounting: See Mental Accounting.
Endowment Effect: Tendency to overvalue assets simply because you own them, leading to reluctance to sell at fair market prices.
Fear of Missing Out (FOMO): Anxiety that others are experiencing better investment opportunities, driving impulsive buying during hype cycles.
Framing Effect: Different responses to same information depending on how it is presented (describing as 90% success vs. 10% failure rate).
Herd Behavior: Tendency to follow crowd behavior during periods of uncertainty, buying what others buy and selling during panics regardless of fundamental analysis.
Hindsight Bias: Tendency to believe after an event that you predicted or could have predicted the outcome, distorting learning from past mistakes.
Home Bias: Tendency to overinvest in domestic equities relative to optimal global diversification, typically holding 70-80% domestic vs. ~50% optimal allocation.
Hot Hand Fallacy: Belief that recent performance streak (winning or losing) will continue, leading to overtrading after short-term success.
Illusion of Control: Overestimation of ability to influence outcomes that are actually determined by chance or external factors beyond investor control.
Implementation Intention: Specific if-then plan that increases likelihood of executing desired behavior (IF market drops 20%, THEN deploy cash reserve).
Loss Aversion: Tendency to feel pain of losses approximately 2.25 times more intensely than pleasure of equivalent gains, leading to excessive risk aversion after losses.
Mental Accounting: Tendency to treat money differently based on arbitrary categories (vacation fund, emergency fund, investment fund) rather than fungible wealth.
Myopic Loss Aversion: Increased risk aversion caused by frequent monitoring of portfolio, leading to overreaction to short-term volatility.
Normalcy Bias: Tendency to underestimate probability and impact of extreme events, leading to inadequate tail-risk hedging.
Optimism Bias: Tendency to overestimate probability of positive outcomes and underestimate risks, common during bull markets.
Overconfidence Bias: Tendency to overestimate own knowledge, abilities, and quality of information, leading to excessive trading and concentration.
Present Bias: Tendency to give stronger weight to payoffs closer to present time when considering tradeoffs between two future moments.
Prospect Theory: Behavioral economic theory demonstrating that people make decisions based on potential gains and losses relative to reference point rather than absolute outcomes, explaining loss aversion and risk-seeking behavior in loss domains (Kahneman & Tversky, 1979, pp. 263-291).
Recency Bias: Tendency to weight recent events and data more heavily than older information, leading to extrapolation of short-term trends.
Regret Aversion: Tendency to avoid making decisions out of fear of later regretting the choice, often leading to status quo bias.
Representativeness Heuristic: Tendency to judge probability of event by how similar it is to prototype in mind, leading to neglect of base rates and sample size.
Status Quo Bias: Tendency to prefer current state of affairs and resist change, causing portfolio drift and delayed rebalancing.
Sunk Cost Fallacy: Tendency to continue investing in losing position because of previous commitment, ignoring that past costs are irretrievable.
Survivorship Bias: Tendency to focus on success stories while ignoring failures that are no longer visible, creating distorted view of actual success rates.
Volatility: Measure of price fluctuation intensity, typically expressed as standard deviation of returns, with VIX index measuring implied volatility of S&P 500 options.
Cross-References
For detailed protocols addressing these biases, see:
- Loss Aversion and How to Counter It
- Overconfidence Bias in Bull Markets
- Disposition Effect and Taxable Accounts
- Mental Accounting in Household Portfolios
- Planning Responses to Big Market Moves
- Designing Automation to Remove Bias
Updates
This glossary is updated quarterly to incorporate emerging behavioral finance research and refine definitions based on reader feedback. Subscribe for notifications when new terms are added.
Academic References
Source: Behavioral economics and finance research.
Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-291.