Understanding Anchoring Bias in Trading

Moving on in life is difficult, whether from a person or a piece of information.

Let’s take an example:

A shirt in a shop costs ₹200, but the shopkeeper suggests a price of ₹100. Now, all negotiations will revolve around the price the shopkeeper suggested.

Say you bargained and asked for a price of ₹50. You may think you got a great deal, but in reality, you may have paid a higher price, and the shopkeeper still earned a good profit.

This is what anchoring bias is about.

What is Anchoring Bias?

Anchoring bias is a mental bias where a trader or investor becomes anchored to an initial piece of information (or old information) and makes decisions based on it, ignoring current market conditions.

• Traders may ignore the current price of stocks and market factors, leading to irrational decisions.

Why Does Anchoring Bias Happen?

In investing, anchoring bias happens when:

• Investors hold onto losing investments because they focus too much on the price they originally paid, instead of evaluating the real value based on facts.

Consequences:

1. Taking bigger risks, hoping the investment will go back to the purchase price.
2. Making poor decisions, like buying overpriced investments or selling undervalued ones.

Example:

• If someone bought stock ABC at ₹100, they keep using that price to decide when to sell or buy more, even if the stock’s real value has changed based on fundamental factors.
• Traders often focus too much on the price they paid for a stock.

How to Avoid Anchoring Bias?

1. Awareness:

   • The first step is to make people aware of anchoring bias and its potential downsides.

2. Keep Emotions in Check:

   • Avoid emotional attachment to past decisions or prices.

3. Stay Updated:

   • Regularly review current market conditions and evaluate stocks based on updated data.

4. Maintain a Trading Journal:

   • Document trades and strategies to ensure rational decision-making.

5. Follow Strict Trading Rules:

   • Stick to a trading plan and avoid impulsive decisions.

By staying disciplined and informed, traders can mitigate the impact of anchoring bias and make better trading decisions.