Modern investment theory is based on the premise that individuals are rational in their approach to financial decision making. Their key objective is to maximize wealth, and they are unbiased in their expectations regarding the future and always act in their own best interests. In reality, individuals sometimes make irrational decisions influenced by mental processes and emotional factors.
Traders in particular tend to be overconfident in their skills and their ability to influence the outcome of uncontrollable events, according to Victor Ricciardi, assistant professor of financial management at Goucher College and a specialist in behavioral finance. Traders often go through a period of time without any losses, and they convince themselves that the winning streak will continue. In gambling parlance, this behavior is known as “the hot hand fallacy.” Interestingly, they are more apt to take profits than realize losses because losses affect their compensation, discredit them in front of their colleagues or can even cost them their job.