The Application of Behavioral Finance in Personal Investment Decision-Making: Cognitive Biases and Market Anomalies

Abstract

Traditional financial theories like the Efficient Market Hypothesis assume investor rationality. However, market anomalies, such as the size, value, and momentum effects, constantly challenge this assumption. This study is centered on exploring the impact of cognitive biases and market anomalies on personal investment decisions. It reviews the theoretical framework of behavioral finance, classifies cognitive biases into those in information-processing and decision-execution as well as individual and group biases, and conducts four case analyses of overconfidence, herd behavior, loss aversion, and other biases. By linking cognitive bias mitigation to market anomaly exploitation, the study demonstrates how behavioral tools can systematically address irrationality while uncovering profit opportunities. The results indicate that cognitive biases cause investors to make irrational decisions. Market anomalies, on the other hand, present chances for obtaining excess returns. Behavioral finance offers a more practical decision-making framework. It enables investors to identify biases, take advantage of anomalies, and optimize their portfolios. This, in turn, helps them recognize biases, utilize anomalies, and optimize portfolios, thus enhancing investment decision-making and improving financial outcomes.