Anchoring Bias :The tendency to rely too heavily on the first piece of information received
Most vegetable vendors in Indian markets use this bias to great effect while bargaining with buyers. The first quote that they give is high but not so high so as to drive the buyer away. And then the negotiations anchor around the first quote. Sometimes the buyer will wear him down and sometimes they get the better of the buyer.
Even auction houses use this bias by setting a reference price or a reserve price. Given below is an example of a bid for a wine bottle. Both the bidders are first asked their social security number and then asked to bid for the bottle. Both give widely different bids, which are close to their social security number.
In the context of investing, this effect plays out when investors get anchored to their buy price. All their future decision making then is referenced around this buy price. And then this bias feeds into the Disposition effect that I wrote about here.
Remember Disposition Effect is the effect to hold on to losers and sell winners early.
And once price goes below the buy price, most investors will not sell it until is comes back to break even i.e. the buy price. Another way it plays out is when a stock falls from a recent high and buyers rush, anchoring their reference point to the recent high and think they are buying at a discount.
Tomorrow we will tie up the key biases that I have written about.
You can read more about Anchoring Bias here
Regards
Anish
Important Disclaimer: Please do not treat anything on my blog as investment advice. I do not provide any recommendations of any stocks or securities. Any stock mentioned may be merely by way of an example.
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