But they will definitely fail to capture the rapid changes in the market. In this scenario, past figures show the historical prices of the stock over a certain time period. It doesn’t mean that because it trended nicely in the past, that it will trend nicely in the future. Consider the potstock sector for example. Investors look at the historical values of a particular stock, become anchored to them, and base investing decisions on them. Likewise, one of the most common anchor traps in investing is past events and trends. Historical values, like acquisition prices or high-water marks, are common anchors. The end result, you to cling to a stock that’s tanking. Or, worse yet, the “endowment effect.” This phenomenon can cause you to overvalue something simply because you own it.
What about selling Facebook just because the company’s stock hit a round number, like $300 a share. Another scenario might be buying a stock that briefly rose from trading around $65 to hit $80 and then fell back to $65, out of a sense that it’s now a bargain (anchoring your strategy at that $80 price). If you find yourself having a specific and perhaps arbitrary number in mind that sways your decision-making, you’ve fallen prey to anchoring. But nope, once again, a decision was made irrationally, and they bought Telsa in error. They’d see that Telsa wasn’t a deal because the fundamentals don’t support a comeback it hasn’t hit rock bottom yet. ROKU doesn’t fall, nor does Telsa recover. They sell ROKU, which is doing well fundamentally without taking the time to analyze it. And ROKU’s gotten too expensive, it’s going to fall.” If ROKU stock rises from $100 to $200, and Tesla has fallen from $150 to $80, what do people do? Well, they think, “Oh, Tesla’s so cheap here, it’s definitely going to come back. For example, pretend that you own stock in both ROKU and Tesla stock. Or, that they did a transformative deal or something similar. Consequently, we don’t take into account the fact that they announced high earnings last week. Since that’s the price, we tend to think of $100 as a fair value for that stock. Let’s look at a stock that’s been trading around $100 a share for the last year. Anchoring ExplainedĪnchoring bias in finance can take on several forms. Unfortunately, anchoring bias in finance happens when you give more weight to the initial piece of information (the anchor) when deciding which action to take. What I explained above is an example of a psychological trap known as anchoring bias. Whereas instead of you feeling like you’d made a profit, you’d feel foolish knowing there was an opportunity to earn way more. How do you think would you feel? Well I think its safe to say you will feel very crappy for leaving money on the table. Not long after, you discover it’s worth at least $12.5 million. A collector offers you $1 million for the piece you turn it down immediately because you “know” it’s worth $5 million.įast forward a few weeks later, a museum calls and makes you an offer of $6.3 million for the painting which you happily take.
You then decide to put the painting for sale. A little bit of time passes, you lose your job and find yourself in a tight spot financially. Attached to the painting on the back is a handwritten note saying it’s worth $5 million. Imagine this scenario: you inherit a painting from your late grandmother’s estate.
#The anchoring trap how to#
How to Prevent Falling Victim to Anchoring Bias in Finance.How Does Anchoring Bias Affect Decision Making?.
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