Cognitive Psychological Theory

Cognitive Psychological Theory in behavioral finance explores how our thoughts and beliefs affect our financial decisions. It suggests that individuals often rely on mental shortcuts, biases, and emotions, leading to irrational choices, such as overreacting to market news or following trends without critical analysis. For example, people might hold onto losing investments hoping they’ll recover, influenced by loss aversion—the fear of losing more outweighs the desire to gain. Understanding these cognitive biases helps explain why investors often behave in ways that deviate from traditional economic theories, which assume people always make rational decisions.