Anchor’s Away

Buy low, sell high.

Diversify.

Let your winners run.

Sell your losers quickly.

These are the simple axioms of investing. And yet, they’re some of the hardest principles for experienced and novices to follow.

Time and time again I’ve watched as investor losses mount due to an unwillingness to sell a stock at a lower price than what was paid for it. In fact, that behavior is so common that there’s actually an industry term for it: anchoring.

Investopedia defines anchoring as “the use of irrelevant information as a reference for evaluating or estimating some unknown value or information. When anchoring, people base decisions or estimates on events or values known to them, even though these facts may have no bearing on the actual event or value.”

A good example is someone who pays $50 for a share of stock. Not long after the purchase it is trading for $40. Is it natural to sell it to cut your losses and move on? No, our brain “anchors” in on the $50 price. We think $50 is what the price should be even though the true value is whatever someone is willing to pay currently and in this case it’s $40. So we hang on to the stock hoping and hoping that it goes back up. Sometimes it does, but often the price continues down adding to the losses.

In order to sell quickly and move on to the next trade investors have to, a) overcome the cognitive bias of anchoring, and b) admit their mistake. That is, they need to accept that the analysis and decision making that went into the purchase decision was flawed or simply incorrect. Rather than sweep the mistake under the rug, I advise investors to capitalize on the experience by making it a teachable moment. By reviewing and analyzing the factors that drove the purchase decision, investors can improve the chances of not making the same mistake in the future.

No professional investor will ever chalk up their success to luck. Experience, learning from mistakes, perseverance, discipline, and an awareness of the cognitive biases humans have when investing all are part of what it takes to make repeatedly good investing decisions.