How anchoring bias affects the way you judge share prices

Have you ever felt a share is 'cheap' just because it was much higher last year? That feeling often comes from anchoring bias. This page explains what anchoring bias is, how it shows up in investing and how to reduce it.

Quick answer

Anchoring bias is the habit of relying too heavily on the first piece of information you see, called the anchor, when making a decision. In investing, the anchor is often a past price, such as the price you paid or a 52-week high. Investors then judge a share against that number instead of its current value and fresh facts.

Key takeaways

• Anchoring bias means sticking too closely to a first number.
• Common anchors are purchase price and past highs.
• It can make a falling share look cheap when it is not.
• It was described by Tversky and Kahneman in 1974.
• Fresh research and clear rules help reduce it.

What is anchoring bias?

Anchoring is a mental shortcut. When you have to estimate a value, your mind starts from a number you already know and adjusts from there. The problem is that the adjustment is usually too small, so the first number keeps too much weight.

Psychologists Amos Tversky and Daniel Kahneman described this in a 1974 paper. In one test, a random number shown to people affected their later guesses, even though it had nothing to do with the question.

Examples of anchoring bias in investing

A common case is the purchase price. If you bought a share at Rs 500 and it falls to Rs 350, you may wait to 'get back to Rs 500' before selling. The market does not know or care what you paid, so this anchor can lead to poor choices.

Another anchor is the 52-week high. A share that was Rs 1,000 and is now Rs 600 can look like a bargain. But if the company's profits have fallen, the old price may no longer make sense.

Why anchoring bias is costly

Anchoring keeps attention on an old number while the facts change. A company's results, debt or industry may shift, yet the investor still compares the price only to the anchor.

This can make people slow to update their view. It also links with loss aversion, since selling below the purchase price makes a loss feel final.

How to reduce anchoring bias

Start from the business, not the old price. Look at current earnings, cash flows and valuation ratios such as the price to earnings ratio before forming a view on price.

It also helps to write down why you hold a share and what would change your mind. Ask yourself: would I buy this share today at this price, based only on what I know now? Pre-set stop loss and review rules can also reduce emotional anchors.

The key point to remember

Anchoring bias is a natural habit, and everyone has it to some degree. Being aware of it is the first step. Judging each decision on current facts, not past numbers, is the practical fix.

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