Anchoring Bias in Investing, Explained
Anchoring bias is a form of cognitive bias where people tend to place extra importance on the first piece of information they get about a topic, regardless of how accurate that data point is.
In investanchoring bias can lead investors to ignore opposing viewpoints or trust incorrect information. This ultimately leads to poor decisions, such as pursuing the first investment or strategy they think of rather than looking for better alternatives or adapting to a changing market environment.
Psychologists have done many studies supporting the notion that anchoring bias is real and significant. Scientists generally agree that the human brain is designed to “hardwire” new information about new topics to facilitate faster decision-making.
In some cases, studies show that information about totally unrelated topics also anchors itself in our brains for a short time. For example, an MIT study asked participants for the last two digits of their Social Security number, then immediately asked them to participate in a so-called auction of random goods. It might sound crazy, but those with higher Social Security numbers paid higher average prices — even though these two topics are unrelated.
In the larger picture of human evolution, anchoring bias is good because it’s one of the reasons our species has survived. Through grounding, we can make decisions more quickly and subconsciously recall limited information to guide our choices rather than just guessing.
Of course, while anchoring bias may have helped early humans make sense of the world, it can be a big drawback in a modern age that requires complex decision-making skills. Navigating through an overload of information sources, reconciling conflicting opinions, and thinking about the context of data rather than raw numbers are equally necessary skills.
Anchoring bias can make it difficult to objectively process a constant stream of rapidly changing information.
First impressions aren’t always correct, but sometimes they are. Therefore, anchoring bias does not always lead you down the wrong path.
But in all areas of life, and particularly with regard to stock Exchange or economic data, things are constantly changing. It is therefore important to avoid acting solely on first impressions. The initial information that creates an anchor in your brain can be valuable and proven correct, but that doesn’t mean it shouldn’t be challenged and validated over time.
Absolutely. Just because anchoring bias is a natural hazard doesn’t mean we all have to be slaves to it.
As with many other cognitive biases, the most important thing is to be aware that it exists and that we fall into this behavior unconsciously. Once you make a conscious effort to identify and understand these cravings, you can counteract their negative influences.
One way to combat the risks of anchoring bias is to delay decisions and be more thoughtful. Again, the evolutionary advantage of anchors in our brains is that they allow us to quickly make connections based on limited information. But for many decisions, being deliberative and collecting more data is much better than just following instincts based on incomplete information.
In short, stop and think, and do it objectively and thoroughly.
Wall Street is an incredibly complex place, awash with conflicting data and stories, as well as outright lies masquerading as legitimate information. It is therefore particularly important for investors to thoroughly research and validate trendsnot just guessing based on the first thing seen or heard.
Anchoring bias is one of a large group of unconscious biases that can interfere with profitable investing. For example, a close cousin is confirmation bias, where people tend to seek out information that only reinforces existing viewpoints. There is also a recency bias, where people tend to put more emphasis on what just happened as opposed to older events. The more you understand about these unconscious tendencies, the more you can control your cravings and keep a cool head when the going gets tough.