Behavioral finance in Forex

Economics and psychology are not strangers to one another. In fact, they have been closely linked for a long time now, although it can be said that in the mid 20th century, psychology has disappeared a bit from the field of economics. But it has not disappeared entirely rather, it is still examined and researched today. The more we understand about psychology, the more we understand human behavior, the more we understand the economic decisions that people make. It is for this reasoning that Behavioral Finance, is called exactly that—‘Behavioral Finance’.

Behavioral Finance applies scientific psychological research on to finance. It looks at human psychology as to understand not only the economic decisions that people make, but also how these decisions end up affecting market prices. In order to do so, researchers look at human and social cognitive and emotional biases developed from experimental observations, survey responses, but also from MRIs for example (that show which area of the brain is active during which steps of the decision making).

Here are a few concrete examples of Behavioral Finance, which are also relevant to the Forex market.

•	Loss Aversion—falls under the category of ‘prospect theory’. It refers to the fact that people prefer to avoid losses more so than they prefer to acquire gains. I.e. losses are more powerful than gains.
•	Money Illusion—refers to the fact that people do not think of currency in real terms (but in nominal terms).
•	The Disposition Effect—refers to the fact that people usually sell shares whose price is increasing and usually keep assets whose price is dropping in value.

If you find the above interesting and helpful, do research the below list of theories/models:

•	Endowment Effect
•	Inequity Aversion
•	Reciprocity
•	Inter-temporal Consumption
•	Present-biased Preferences
•	Momentum Investing
•	Greed and Fear
•	Herd Instinct
•	Sunk Cost Fallacy
•	Equity Premium Puzzle
•	Efficiency Wage Hypothesis
•	Price Stickiness
•	Limits to Arbitrage
•	Dividend Puzzle
•	Fat Tails
•	Calendar Effect
•	Cognitive Framing
•	Mental Accounting
•	Anchoring, Prospect Theory
•	Status Quo Bias
•	Gambler's Fallacy
•	Self-serving Bias