The saying ‘buy low, sell high’ is a mantra often echoed by investors. However, what defines ‘low’ or ‘high’ for us? This is where the concept of anchoring bias comes into play.

Anchoring bias, first identified by psychologists Amos Tversky and Daniel Kahneman, describes our cognitive need to establish a benchmark in complex situations. In investment contexts, this manifests as psychological attachment to initial reference points: purchase prices, analyst forecasts, historical highs and lows, or IPO valuations. Like assessing today’s temperature based on yesterday’s readings, investors frequently use these arbitrary anchors to guide future decisions, even when market conditions or fundamentals have fundamentally changed.

Research demonstrates that anchoring effects are remarkably persistent. Even when investors receive contradictory information that should logically override their initial anchor, the influence of that first reference point continues to shape decision-making processes, often to their financial detriment.

So, how does anchoring bias affect our investing habits?

It can make an investor stubbornly adhere to the initial price they paid for a stock, ignoring evolving market conditions or underlying fundamentals. An investor may hold onto a declining stock, hoping for it to rebound to the purchase price, or prematurely dispose of a profitable stock, tied down by an arbitrary target price.

The cryptocurrency market provides a compelling illustration of evolving anchoring bias effects. Bitcoin recently shattered expectations in 2024, achieving new all-time highs above $100,000 and reaching over $180,000 recently, creating fresh psychological anchors for investors. While those who previously anchored to Bitcoin’s 2021 peak of $87,000 have been vindicated by this dramatic appreciation, new anchoring challenges emerge. Current investors now face the psychological challenge of anchoring to these unprecedented price levels, with analysts predicting potential targets ranging from $200,000 to $250,000 by late 2025. The danger lies in investors becoming anchored to recent peaks, potentially leading to poor timing decisions if markets experience inevitable corrections from these elevated levels.

How can investors, counteract the influence of anchoring bias?

Acknowledging its existence is the first step. Following this, the focus should shift to a comprehensive analysis and fact-based information. Although historical data has its role, making decisions grounded in a wide spectrum of current data is more likely to yield successful investment results.

Moreover, adopting a long-term investment strategy can diminish the sway of anchoring. By focusing on enduring trends over temporary fluctuations, investors can sidestep fixation on irrelevant reference points.

While anchoring bias may be an inherent cognitive shortcut, an understanding of its impact and proactive measures to counteract it can guide investors to navigate the dynamic investing landscape more proficiently.

Moreover, adopting a long-term investment strategy can diminish the sway of anchoring. By focusing on enduring trends over temporary fluctuations, investors can sidestep fixation on irrelevant reference points.

While anchoring bias may be an inherent cognitive shortcut, an understanding of its impact and proactive measures to counteract it can guide investors to navigate the dynamic investing landscape more proficiently.