Evolution has equipped us with many automatic survival mechanisms called instincts. For example, we apply mental shortcuts as a subconscious survival mechanism to help the brain expedite it’s decision-making and information processing. The brain performs this task by selecting an initial reference point and then basing it’s decisions around that point.
One example for such a shortcut is what we call ‘Anchoring’ in Neuro Linguistic Programming.
I recently experienced anchoring first hand and I know you will realise you have many similar experience: Last week I bought Salmon which was on special in Woolworths reduced from $11.99 to $9.99 and I thought, wow that’s a great saving. The following day I went to Coles and it turned out that their ‘normal’ price for the exactly same brand of salmon was $10.49. Suddenly my Woolies bargain wasn’t such a great deal any longer, I got fooled!!
This is a perfect example of how companies use this bias called anchoring to their advantage. The initial asking price serves as an anchor or reference point in our mind for making us believe what the item might be worth, and the sales price is then set with the initial anchor in mind.
It is also a common strategy in the property market. For example, a vendor is looking to get $450,000 for their house, the agent will most likely set the offer for let’s say, $500,000 which will then serve as the anchor in the buyer’s mind.
One way anchoring works against traders is when the trade went into profit by lets say $1000 before dropping back. Then your focus shifts from following your trading strategy to hoping to get back to that 1K profit where you promise that this time you will take it.
And this is the moment where most traders are being let astray. Their focus shifts from executing their strategy and evaluating the possibility of the trade to continue according to their analysis to becoming outcome or profit focused, trying to ‘will’ the market to move back to the price that could given them a $1000 profit rather than following their analysis. And by becoming ‘married’ to a certain profit they want to achieve again they often end up in a massive loss.
Or something that has happened to me a few times before I realised what was going on in my mind: I just wanted 1 more point so that the dollar amount on my trading account is round. It looks so much better if your trading account shows $xx,001 rather than $xx,999.83, right? The only comfort I have is that I am not alone.. quite a few traders have given back their whole day’s profits from chasing just another 10 cents.. In the end you need to work with what the market has to offer not what looks pretty on your screen!!
This example demonstrates the dangers of letting the brain ‘do it’s thing’ without having an awareness of it. It is natural for the brain to select an anchor (as a shortcut) around which to make decisions, but if you are aware of this then you will not be prone to letting those anchors influence your decision-making when it comes to trading. This shortcut may have evolved as it is useful in other areas of your life, but when it comes to trading, it often leads to poor decision-making with painful results.