Pendulum.
There was a chapter in the book “Thinking, Fast and Slow” written
by Daniel Kahneman (published 2011), that talks about a phenomenal event that
is very observable in the stock market, the “Anchoring Effect”. According the
Kahneman, anchoring “occurs when people consider a particular value for an unknown
quantity before estimating that quantity”.
Anchoring happens in the stock market when
we accept the price of a stock based on the momentary price that we see on the
screen without further validation if the price of a stock is reasonable. That
is, the present price that we are seeing is serving as the anchor. For example, some stock players buy stocks without comparing
prices or looking at the financials of the company. It might happen that you have
bought a stock at a higher price with a lower value (the rational choice is to buy a
high-value company at a bargain price). If you bought company A at a higher price
compared to company B; and company B’s asset and income are higher compared to
company A, that means that you have made a wrong choice.
Easy illustrated than practiced in the real world, preventing
one’s self to be anchored on the stock price is difficult. That is the reason
why some people lose their money on the stock market. They were anchored by soaring
prices believing that it will still go up. To combat this phenomenal anchoring
effect, we should ask our selves if the price of the stock is right. And if you
find your self in doubt, don’t invest – make sure first that the price is right
by doing research. If you still doubt your research – don’t invest. Remember
that worthwhile investment should be based on sound research.
Daniel Kahneman is a well known for his work in behavioral
economics in which he was awarded a Nobel Memorial Prize in Economic Sciences.
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