According to Investopedia, anchoring is a behavioral finance term to describe an irrational bias towards an arbitrary benchmark figure.
This means that an investor is often subconsciously is affected by a fixed reference point (anchor) such as the purchase price of a stock, when making subsequent decisions about the stock.
In other words, if you bought a stock at $50, you tend to be unconsciously affected by your original buy-in price, and this affects your future decisions to buy/sell.
This becomes an issue when you buy a good stock at a low price.
For instance, if you bought a good stock at $50, and it keeps going up, you find yourself unable to decide when to average in, because you keep thinking back to your original buy-in price.
You then miss out on the 5x, 10x gains to follow.
This also applies when selling a stock, you use your buy-in price as an anchor, and may sell too fast, instead of holding on.
So what can we do to overcome this?
1. Common anchors in investing
Studies have shown that investors are inevitably influenced by anchoring bias, even professional analysts and traders, and it is difficult to completely rid yourself of this bias.
Nevertheless, being aware does help.
So what are common anchors in investing?
- Original buy-in price
- 52-week high or low price
- Short term volatility (high/low price)
- Information / news cycle
Know your triggers – what factors tend to affect emotional decision-making?
2. Go back to fundamentals
The goal is to rid yourself of bias, and go back to fundamentals.
When deciding whether to buy, sell or hold, think about whether you are taking into consideration the available information.
Try to take a step back and be objective.
Consider the fundamentals i.e., the economy, the industry and the company.
You can actually re-set your anchor, based on your objective analysis.
You can use anchors to your advantage, to execute your investment strategy.
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3. Think about position sizing
Another option is to remind yourself of position sizing.
How much of X stock do you want to own?
For instance, you actually want to put 50k into a stock.
You first put 20k at $10, and now the price is $20. Do you let this stop you entirely?
After considering the fundamentals, you think the fair price is actually about $25.
So in this case, does it matter that the stock price has gone up? You originally wanted to invest 50k anyway.
This is also why many investors are a fan of Dollar-Cost Averaging (DCA) as it tends to take out the more emotional aspects of investing, and eliminate unwanted behavioural patterns.
4. Practice the Pause
Have your own investment thesis before you buy any stock – and write it down!
Go back to it whenever you are confronted with an anchoring bias situation. Adjust your hypothesis if there has been a change in material factors.
Try not to be hasty. Practice the pause.
Sleep on it before you act.
Sell 1/3 or buy 1/3 of your desired positioning, there’s no need to go all-in immediately.