Anchoring is a shortcut that is used, by selecting an initial reference poinr (the anchor), the brain only need to process additional information that is received instead of reassessing all the facts that were received from the beginning.
When investing, this tendency often results in investors "anchoring" to their own estimates of a company's earnings or the "fair value" price of a share.
In a bull market, investors can also "anchor" each new high achieved by a security ti its previous highs abd the new higher recent price is taken as evidence of value.
The share's distant price history appears irrelevant to any desicion-making. The effect of anchoring on an investment desicion is similar to the fear and regret (previous post). The recent price of the share that is used as a psychologial anchor slows down rational valuation estimates. Losing positions will be held too long and winning stocks will be sold too quickly.
WHAT TO DO?
Investors are always upset and regret not executing their transactions at the highest or lowest prices. But the highs and lows are not accurate benchmarks as the share may only be at that price for two hours in a single day. It is better to compare your sale or purchase price with the average rpice of the security across a two-week duration. Also, remember that market participants are not the same as before. We have more hedge funds woth billions of dollars invested int the market and they can be very aggresive. This is when prices of securities can be pushed up or down very quickly.
Anchoring can lead to a strategy of buying stocks that have fallen considerably in hopes of buying it "cheap". Investors anchored to a recent (high) price value take this as an indication of value, and the new (low) price appears chaep. To avoid this pitfall, check your intentions in buying a security that is on its way down. If you had evaluated the security and determined that you would like to accumulate a position in this company, then it can be beneficial to take advantage of any price weakness in the share price cause by the overall market sentiment. On the other hand, be alert if a sharp price decline is the primary motivator behind your desicion to buy and a recent higher price is a main factor in the stock's attraction.
When investing, this tendency often results in investors "anchoring" to their own estimates of a company's earnings or the "fair value" price of a share.
In a bull market, investors can also "anchor" each new high achieved by a security ti its previous highs abd the new higher recent price is taken as evidence of value.
The share's distant price history appears irrelevant to any desicion-making. The effect of anchoring on an investment desicion is similar to the fear and regret (previous post). The recent price of the share that is used as a psychologial anchor slows down rational valuation estimates. Losing positions will be held too long and winning stocks will be sold too quickly.
WHAT TO DO?
Investors are always upset and regret not executing their transactions at the highest or lowest prices. But the highs and lows are not accurate benchmarks as the share may only be at that price for two hours in a single day. It is better to compare your sale or purchase price with the average rpice of the security across a two-week duration. Also, remember that market participants are not the same as before. We have more hedge funds woth billions of dollars invested int the market and they can be very aggresive. This is when prices of securities can be pushed up or down very quickly.
Anchoring can lead to a strategy of buying stocks that have fallen considerably in hopes of buying it "cheap". Investors anchored to a recent (high) price value take this as an indication of value, and the new (low) price appears chaep. To avoid this pitfall, check your intentions in buying a security that is on its way down. If you had evaluated the security and determined that you would like to accumulate a position in this company, then it can be beneficial to take advantage of any price weakness in the share price cause by the overall market sentiment. On the other hand, be alert if a sharp price decline is the primary motivator behind your desicion to buy and a recent higher price is a main factor in the stock's attraction.
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