Anchoring Bias
IntermediateAnchoring bias is the tendency to rely too heavily on the first piece of information encountered, called the anchor, when making judgments and decisions, even when it is not relevant.
People often use an initial number as a reference point and adjust from it, but usually not enough. Psychologists Amos Tversky and Daniel Kahneman showed this effect in experiments where even random numbers influenced people's estimates.
In investing, a common anchor is the price paid for a share. An investor who bought at 50 may refuse to sell while it trades at 35, waiting for it to get back to 50, even though the purchase price has no bearing on the company's future prospects.
Other anchors include a share's recent high, an analyst's first price target or the asking price of a house. In negotiations, the first offer often acts as an anchor that shapes the final outcome.
Anchoring can lead investors to hold losing positions, misjudge value and underreact to new information. Reducing its effect involves asking what an investment is worth based on current information, considering a range of possible values and asking whether one would buy the investment today at the current price.
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