A Comprehensive Review of Human Psychology’s Role in Shaping Stock Market Investments: Behavioral Finance Insights

Most investors view the stock market as a place to trade shares where everything is well organized based on data and economic factors. Investors behave rationally after analyzing the market based on related data and news.  However, behavioural finance shifts the traditional view, emphasising human emotions and cognitive bias. This review explores the intersection of how human psychology, such as cognitive bias, emotion, and cultural background, drives retail investment decisions across global stock markets in the past decades. Important psychological aspects of loss aversion, overconfidence, herding, and anchoring are examined to determine how they affect market efficiency and the pricing of assets. In the review, we outline the evolution, strengths, and weaknesses of financial theory and models from classical paradigms like efficient markets hypothesis, CAPM, through behavioral finance to emerging neurofinance. In addition, we consider both qualitative and quantitative research concerning cognitive and emotional biases, such as overconfidence, herding, and loss aversion, which influence the decision-making processes of individual investors. By combining empirical data and theoretical models, this review offers a better view of the reasons behind unregulated markets and the role played by cognitive biases in destabilizing the market. The findings point to applying approaches in investment and financial literacy to help curb the detrimental effects of irrational thinking.