Behavioral Finance for the Individual Investor

The Efficient Market Hypothesis (EMH) has been generally accepted in academia despite its well-researched flaws; by understanding how and when markets deviate from efficiency, investors have an opportunity to not only better understand their investing habits, but also possibly generate higher investment returns. Various market anomalies, such as the Value Effect (De Bondt & Thaler, 1985), the Monday Effect (French, 1980), and the January Effect (De Bondt and Thaler, 1958 & 1987), attest to the fact that markets experience periods of deviation from efficiency. Fiévet and Sornette (2016) finding that markets experience inefficiency during periods of significant volatility is confirmed by behavioral finance, which explains how behavioral heuristics influence investment decisions, specifically greed and fear (p.38). Andrew Lo based his substitute for the EMH, the Adaptive Market Hypothesis (AMH), on the supposition that markets become inefficient because of irrational investor behavior (Urquhart & McGroarty, 2016). In applying these concepts to an individual’s portfolio, it could provide great insight into their own trading patterns; for investors with higher risk tolerance, these theories could help produce larger returns for their investment portfolios