It might. We all have our anchor points and not all will be in good nick. But first, what do we mean by anchoring bias? And why do we need to keep whipping it into line?
The anchoring effect is the over-reliance on early information that could blot out other opportunities – often better ones – as new information comes to light. They are your mental fixtures.
Anchoring psychology might lead you to make not just bad trading choices but buying the wrong property. Or a tasteless lump of supermarket cheddar. Even picking the wrong partner. These cognitive psychological biases are present in love, marketing and just about everything. Even design.
Anchoring is present even in...cheese: Shutterstock
Say you’re shopping for a new car. A relative has told you diesel vehicles are going the way of the dodo. Clean air laws will decimate future diesel values. On their advice you buy a £25,000 hybrid. Its environmental credentials are beyond reproach.
But its range is laughable and the real-world infrastructure to juice it up 200 miles from home isn’t there. You bought it because you over-relied on information from one trusted source. You ignored the diesel model that’s cheaper and works better in the real world.
That’s anchoring bias, writ large – you focused on that first piece of information given to you – and you lost a ton in depreciation as you drove out of the showroom.
Anchoring in practice
Now let’s look at anchoring bias in terms of trading and investing. Let’s say you’ve bought into XYZ shares. It’s a growth stock widely respected with a strong defensive hedging element. A bit unusual but you rate it.
Unfortunately, XYZ surprised the market at a recent trading update. It struck a new acquisition with a supplier. This acquisition was expensive and the debt burden huge.
Several major investors sold, and the share price slumped from £50 – close to your original entry point – to £38 in a week, despite the dynamics between the two companies being well understood.
Your inner anchor bias whines: but this share is worth at least £50. This £50 figure, then, has become your fair value ‘anchor’. To you, anything less than your £50 anchor is unfair.
The market, in fact, was behaving perfectly rationally. Less understood by you was that XYZ’s new partner had been overvalued. The deal wasn’t as strong as it first appeared. Because you stuck to the £50 reference point you own a share that’s over-valued. Your rational, critical self has let you down.
Imagine how this behavioural bias might affect you if you applied the same instincts across a whole sector. Eek.
Anchoring affects just about every stage of trading life. From where you set your stop losses to taking profits and other entry and exit points. Once you are aware of how damaging anchoring can be to your trading, you become able to make adjustments to compensate. Or at the least, be aware of its presence.
Remember, your original buy-price or sell-price anchor point is irrelevant to the rest of the market.
Learn to protect yourself – keep your eyes fresh
Avoiding anchoring bias, then, is about looking at a situation from as many angles as possible and giving a fair weighting to each (which might not be an equal weighting). That sounds straightforward but it’s actually very difficult.
Time is short. Our feelings are always changing. Apply these second-by-second variables to your trading and you get the idea that anchoring can clobber your trading results.
The market is awash with information. It’s important to be selective, but not over-picky. Don’t focus too much on information that might reinforce existing prejudices.
You will need to constantly renew your judgement as news and updates are changing.
The anchoring heuristic and its extended bloodline, (see below) apply to amateur and professional traders. No-one’s left out. The difference is that professional players have more tools to deploy, and more kit to question and analyse their decision making.
Anchoring bias stops you from making rational decisions – crucial for successful trading. The current price is what matters most – always. Forget about that first price, the artificial anchor.
You must meet the family
Anchoring bias has a big family, not to mention several hangers-on. One closely related bias to anchoring bias is recency bias. As the name suggests, it’s a bias towards recent events, be they profits, losses or stasis.
So be careful to learn from experience over time – not just the past week, month or quarter. Recency bias can also apply to habits and strategies.
Another is bandwagon bias. As the name implies, it’s a leaning to what other people are doing. One in-built problem with recency bias is that it tends to remove the pressure to make independent, subjective judgements. It’s too bound up with news or market commentary and ‘noise’. Just because everybody else is doing something doesn’t make that the right thing to do.
Status quo bias is another family member with financial health issues. Again, it may suggest your trading behaviour is too bound up in stocks you have liked and traded for a long time. Status quo bias feeds passivity and an inclination to avoid change.
Lastly, a quick look at disposition bias. At the root of disposition bias is the anxiety of potential losses. You own a stock that has risen in value. The fundamentals remain solid but you sell early because you just ‘know’ the recent surge in its share price won’t last.
It goes the other way: you don’t sell a badly performing share because you’re certain momentum will come back – it’s inevitable.
Anchoring is all around
• Supermarkets love anchoring. It allows them to claim what great deals you can get: Spanish Rioja reduced from £7.99 to £5.99. Save £2! An ‘everyday’ low price – say £5.99 – doesn’t have the same pull. Supermarkets flog discounting whether it’s real or not. (The technical name at work here is optimisation conversion.)
• Your mother dies at 50 and your dad at 60. If you live to 70 that doesn’t look bad for family longevity. But if you die at 35 you would feel – were you alive to have the thought – short-changed
• You are competent at your job and your clients appreciate your conscientious work. But you’re missing targets set at the start of your contract. Your work ‘anchor’ is falling short
• You need a winter coat for warmth and protection. You buy a coat for its intrinsic value. You have ignored all benchmarks and anchoring not to mention myriad over-priced designer labels. Many congratulations
To get more trading psychology insights watch our 5 most common trading mistakes video with David Jones: