Anchoring bias refers to our psychological inclination to place excessive emphasis on the first piece of information we receive (known as the 'anchor') when making decisions.
The saying ‘buy low, sell high’ is a mantra often echoed by investors. However, what defines ‘low’ or ‘high’ for us? This is where the concept of anchoring bias comes into play.
This bias arises from our cognitive need to establish a benchmark in complex situations, essentially serving as a mental shortcut to decipher the complexities of our surroundings. It’s similar to assessing the temperature of today based on yesterday’s readings. In the sphere of investment, however, this reference point can lead to potentially damaging financial decisions.
So, how does anchoring bias affect our investing habits? It can make an investor stubbornly adhere to the initial price they paid for a stock, ignoring evolving market conditions or underlying fundamentals. An investor may hold onto a declining stock, hoping for it to rebound to the purchase price, or prematurely dispose of a profitable stock, tied down by an arbitrary target price.
To illustrate this, let’s look at the cryptocurrency boom in the early 2020s. Many investors had their beliefs firmly anchored to the soaring valuations of digital currencies and their seemingly limitless growth potential. However, when the market experienced a substantial correction, numerous investors, anchored to these high valuations, were taken aback.
How can investors, counteract the influence of anchoring bias? Acknowledging its existence is the first step. Following this, the focus should shift to a comprehensive analysis and fact-based information. Although historical data has its role, making decisions grounded in a wide spectrum of current data is more likely to yield successful investment results.
Moreover, adopting a long-term investment strategy can diminish the sway of anchoring. By focusing on enduring trends over temporary fluctuations, investors can sidestep fixation on irrelevant reference points.
While anchoring bias may be an inherent cognitive shortcut, an understanding of its impact and proactive measures to counteract it can guide investors to navigate the dynamic investing landscape more proficiently.
