Updated: Jan 12
One thing is, don't count on it to help you.
What is Anchoring?
Not that kind of an anchor, where it's used to prevent ships from drifting water into the sea. We're talking about something that can be destructive...to your personal finance and money-making decisions. Okay maybe we're being a bit dramatic but anchoring is a behavior bias that involves using irrelevant information, or information from the past, to base current decisions.
So for example, an investor under the anchoring bias would use a past price on a stock to decide whether or not he should purchase a stock. In constantly referencing that past price point, the investor fails to account for market changes such as inflation. This can lead to the making of incorrect financial decisions.
Why Is It Harmful?
As a result of making erroneous financial decisions such as holding investments that have lost value or buying an undervalued stock, investors face consequences. Because they have anchored the fair value, a rational estimate of the market price of an asset, to the price in their minds, they come to disregard the fundamental evaluation of the stock. By holding onto those investments, the investors face a greater amount of risk since they are betting that their share will increase to its purchase price.
How Does This Apply To Trading?
In other words, if a trader bought a share of Snapchat, SNAP, for $150 then they will continue to remain fixated on that price. The decision of either holding or selling the stock will revolve around the fixated price of $150. This is inadequate because the decision at hand should be calculated with actual value of the stock; not irrelevant factors.
The reference point of such a decision should be made with an assessment of the company, its current price, and whether or not it is performing well. But those under the anchoring bias will base their buy or sell decision on the $150. Accordingly, this contributes to either late entry and exit timing. And late entry and exit timing can lead to long term losses, especially if an investor holds their winners too long.
There's power in financial education, which we want to seek to do. The more you know, the more likely you will be able to avoid little decisions that over time, could add up and impact your finances BIG time. Download our app, Portfolio Shepherd, to learn more about financial concepts and strategies. We'll teach YOU how to avoid being a sheep investor.