Anchoring bias refers to the tendency of over-relying on one piece of information when making decisions, and numerous academic studies have demonstrated how this practice can influence investors’ decision-making processes.
To avoid anchoring bias, ensure your investments are researched extensively using objective sources and that all decisions come from rational places. Also be conscious of tracking how decisions have come to fruition over time.
Behavioral biases in investment decision-making
Behavioral biases can have a significant effect on trading decisions during times of market instability, potentially harming investment portfolio performance. One such form is anchoring bias, where traders rely heavily on an initial analysis or judgement when making subsequent decisions – this can lead to investors holding onto losing stocks longer or selling winning ones too early than necessary.
Cognitive biases such as Purchase Price Bias occur when too much emphasis is given to an arbitrary reference point, such as purchase or sales price, such as when making decisions involving gain-loss evaluation and disregarding probability; other behavioral biases include Herding, Overconfidence and Endowment Effect.
Behavior biases can be avoided through thorough research and market evaluation. Traders must also take into account multiple factors that might influence a security’s price – for instance, basing their decision solely on the fact that an asset sold at its previous high price may result in financial loss.
Disposition effect
Anchoring bias refers to the tendency for investment decisions to be made based on initial inputs such as key forecast inputs or security prices that do not correspond with market prices and lead investors down an unwise path of decision-making. Such anchors include absolute historical values such as acquisition prices or high water marks as well as relative metrics like valuation multiples that lead them down this road of indecision.
Individuals may experience confirmation bias when making financial decisions, leading them to sell losing securities before any possible price rebound and avoid selling stocks which have recently experienced price appreciation, even when they believe the price may be excessively valued. Researchers have discovered that this bias is stronger in volatile markets, yet its effects remain consistent across markets. Furthermore, its magnitude depends on demographic variables. Statisically significant negative and positive coefficients indicate that when individuals exhibit this bias, their portfolio return will suffer accordingly. Additionally, the disposition effect is negatively correlated with both the size and riskiness of an investor’s portfolio (Table 7). Regression model results indicate that these relationships remain valid even in circumstances with different specifications.
Anchoring bias
Anchoring bias is a psychological heuristic that influences people’s judgment and choice of an initial value as an anchor point for decision making. To combat it, active challenge of assumptions and expectations when making important decisions may help people avoid overestimating or underestimating an asset’s worth or undervaluing assets (Englich & Soder 2022). Loss aversion bias also negatively influences investment choices by leading people to fear losses more than celebrate gains (Englich & Soder 2022).
Research on anchoring bias has demonstrated the difficulty investors have in moving away from an initial price and revising estimates accordingly. In one experiment, researchers gave participants an initial price estimate for a beach house and asked them to multiply that figure by a specific factor; researchers discovered that people given general anchors adjusted their estimates more than those given precise anchors due to how their initial estimate has an outsized influence over decision-making processes.
Confirmation bias
Investors with confirmation bias often seek information that confirms their existing beliefs and biases while disregarding evidence that is contradictory to these perceptions. This can lead to poor decision-making and missed opportunities, herding behavior among investors following suit with their peers or “halo effects,” where positive impressions from one aspect of an investment influence overall perception and judgement of it.
Endowment effect bias occurs when investors overvalue assets they own, leading them to make irrational decisions such as failing to sell losing stocks even when markets decline – an outcome of loss aversion bias that undermines an investor’s financial goals.
To combat confirmation bias, it’s crucial to solicit feedback and advice from others with diverse backgrounds and experiences. Doing this will enable you to assess the quality and credibility of information sources as well as different points of view. In addition, challenging assumptions and beliefs which are subject to herding tendencies or overconfidence can also help in order to overcome confirmation bias.