A is for Anchoring
Courtesy of Tim Richards of the Psy-Fi Blog
Anchoring is a simple psychological bias that causes us to focus on some initial value and then make decisions with reference to it. For an investor a typical anchor is a purchase price, and you'll often find people won't sell below that price, although that's wrapped up with other biases such as loss aversion.
Example
My favorite example is an experiment, Explaining the Enigmatic Anchoring Effect, that included so-called implausible anchors for a variety of questions including an estimate of the age at death of Mahatma Gandhi. One group was told he died after the age of 9, another that he died before he reached 140. The former group guessed he died at 50, the latter at 67 (a little knowledge of history would have helped – he was assassinated aged 78). As in this case the anchors were obviously spurious we can see that it's a powerful effect, and an important example of how easy it is to manipulate peoples' responses in areas of uncertainty.
Causes
There's little agreement about exactly what the underlying causes are and, indeed, there's little agreement about whether this is one bias or many (this is fairly typical of all research about behavioral bias I'm afraid). About the only thing anyone can agree on is that it's a real effect and has very real implications for behavior particularly in areas such as negotiation, real-estate prices and stock market investing. So more or less everything important in everyday life, then.
Mitigation
Officially there's not a lot you can do about anchoring, it's fiendishly hard to eliminate, but as the Gandhi example shows, some real knowledge can eliminate the uncertainty and therefore the problem. So understanding how to value a stock correctly would be a good start. And not keeping track of your buying price wouldn't do any harm either.
