Recency bias definition
A recency bias is when you only focus on recent asset performance, or the most recent outcomes, be they successful or not. In other words, this bias is a tendency of a trader to consider the most recent price movements, news or information and ignore or fail to take into account what came before in the past.
Highlights
A recency bias is when a trader only prioritises recent events over historical records.
It may happen due to one’s tendency to rely on short-term memory, or due to limited information.
Recency bias is different from availability and primacy bias.
There are various tools that may help to potentially avoid or moderate recency bias, for example, keeping and re-visiting a trading journal or using a wide range of sources during the decision-making process.
Recency bias explained
The recency effect means that traders may abandon logic and a solid strategy because of running on emotion. This myopia increases the likelihood of a future loss as recency bias may lead to poor decision making. It’s essential to understand this cognitive heuristics as it will help to evaluate why traders may make rash decisions based on recent events and ignore rational components, such as long-term facts and data.
For a better understanding of what recency bias means in trading, let’s take a look at some examples and how it compares to other biases.
Recency bias example
Let’s imagine that Christina has just started trading and doesn’t have much experience in the stock market, but she’s keen to start buying and selling stocks.
Christina has done some research and identified three companies that she would like to start trading. Looking at the data of these companies over the last 10 years, their average annual returns were 20%, 30% and 50% respectively.
An intuitive choice could be the company with 50% return over the past decade. However, Christina decides to avoid this company as she learns that one of the group's investors had recently put money into a firm that ended up going into bankruptcy.
Even though there was no connection between the bankrupt company and the firm with the 50% return, a negative connection was created in Christina’s mind and influenced her decision.
In other words, traders can develop negative associations with a company, irrespective of its past record. This is an example of recency bias.
Reasons behind recency bias
There are many reasons why cognitive biases may happen. Let's look at a few of the potential factors.
Memory processing: The way your memory processes information defines how well it is remembered. Our short-term memory tends to be more easily accessible than knowledge stored in the depths of our brain. The recency impact hence could be reduced by repeating information over time and strengthening those neural connections.
Availability of information: Recency bias occurs when traders are potentially considering too much recent information, and not enough historical data, and hence rely on knowledge that comes to mind easily. This is where recency and availability biases may overlap.
Difference between recency bias and other biases
| Recency bias | Availability bias | Primacy bias | |
| Definition | Tendency to prioritise recent information | Tendency to prioritise information that comes to mind easily | Tendency to recall information encountered first more easily |
| Example | A trader who focuses on a stock’s recent performance and ignores its historical record | A trader who was exposed to the news about stock’s positive price performance forgets to evaluate the company’s latest earnings | A trader prioritises a stock rating he saw first, even though the consensus analyst rating is significantly different. |
How do you identify recency bias?
One way to identify recency bias is to evaluate at what extent your decisions are based on recent events versus historical information.
To evaluate this you could keep track of your trading activity via a trading diary or a trading journal. For each position you open and close you could track the entry and exit levels, and the rationale behind the trade. Later you could analyse your performance and the reasoning behind your decisions.
Another way to identify the recency bias in your trading may be to look at the information you consume and the range of sources you use. For example, if you rely solely on news about the latest market activity you may be more susceptible to the recency bias.
Overcoming recency bias: 6 tactics to consider
Below are some points you may want to consider to combat your recency bias. Note that you should conduct your own research beyond this article.
Improving your knowledge: Asset markets rise and they fall, and they may move in cycles. Understanding the market forces in more detail could help you combat recency bias.
Developing long-term memory: Training your memory to retain information for longer periods could help in avoiding recency bias in your trading. Repetition is key, especially over long periods of time. However, in trading, you may also want to consider relying on data rather than memory only.
Having a trading strategy in place: Setting a trading strategy designed according to your needs and goals could be key in trading. Following a strategy could also be helpful in overcoming cognitive biases.
Keeping a trading diary: Trading diary or journal can help you keep track of your decision-making process, and analyse whether recency bias has been at play.
Using a variety of sources: Using a wide range of sources and tools to conduct your research on an asset. For example, you could use a mix of technical and fundamental analysis, consider the asset’s historical performance, and keep up-to-date with the latest news and analyst commentary, among others.
Keeping your emotions in check: Trading can be a highly emotional activity, especially when a sudden market news results in high volatility. It could be important to maintain self-discipline and consider designing a strategy.
Conclusion
Recency bias is the tendency of a trader to prioritise recent knowledge over long-term historical data, and on occasions could lead to poor decision making. It may be caused by the natural dominance of short-term memory, or by strong exposure to the information about events that occurred recently. Recency bias is different from availability bias or primacy bias.
To combat this cognitive effect, traders could consider keeping a trading journal, developing long-term memory, gaining more knowledge of the markets, using a variety of sources and keeping their emotions in check when setting their trading strategy, among other tactics.
FAQs
What type of bias is recency bias?
Recency bias is cognitive behavioural bias that may lead traders to prioritise recent information over past asset performance.
What is an example of a recency bias?
An example of recency bias is when a trader decides to buy a stock in a company only based on its recent performance, as opposed to also looking at how it has performed in the past.
Are there any ways to overcome recency bias?
There are a few potentially helpful tactics one could consider when looking to overcome recency bias. One of them could be to observe whether the asset’s long-term performance is part of the decision-making process when trading. Knowing the markets and how they behave may also help avoid recency bias, plus having a clear strategy in place, as well as using a wide range of sources and also developing one’s long-term memory. However, note that there are no guarantees, and what works best for one trader may not work for others. You should always conduct your own research before trading, and never trade more money than you can afford to lose.
What is a primary reason for the recency effect?
Recency effect could happen when a trader is overly exposed to information about recent events and does not consider other factors.
