Classical economics assumes humans are rational optimisers. Behavioral economics, pioneered by Daniel Kahneman and Amos Tversky (Nobel 2002), shows the opposite: humans use mental shortcuts that lead to predictable, costly mistakes — especially in financial markets where stakes are high and feedback is slow.

Key biases: Loss Aversion — losses hurt ~2–2.5× more than equivalent gains feel good (Kahneman-Tversky). Anchoring — first number seen becomes reference point for all judgments (IPO reference price, 52-week high). Herding — following the crowd feels safe and drives bubbles. Overconfidence — investors overestimate forecast precision, leading to under-diversification and excessive trading. Disposition effect — sell winners too early (realise gains), hold losers too long (avoid realising loss). All five directly degrade long-term investment returns.