Men are apt to be much more influenced by words than by the actual facts of the surrounding reality.
On this time, we will address a key issue within Behavioral Finance, which are the Psychological Anchors. To have clear opinions from psychology, we present this article written jointly by Steering Bird, online advisors in business direction and management, and Tu Mejor Tú, metas claras para el éxito.
Many times, our responses are conditioned by something. For example, if we ask you to associate a word with the number 7, you will say good luck; to number 13, you will say bad luck. These are simple examples of psychological anchors.
We can understand that, at management level, the psychological anchors are more present within marketing, with advertising campaigns being the ones that carry the banner in this regard. However, we have anchors in all human activities.
When people believe a conclusion is true, they are also very likely to believe arguments that appear to support it, even when these arguments are unsound.
Before beginning, you could try to answer these questions:
- What is the fair price of an item?
- What is the correct value of the stock market?
- When do you consider inflation is high or low?
- Is the price of the latest iPhone reasonable? Would you pay for it?
- Is Microsoft’s stock undervalued or overvalued?
- Are the home prices adequate?
We regret to tell you something. All these questions will have an answer associated with some anchor that you already have. You will surely think, how is it possible? It is no mystery, we simply associate numbers or ideas to generate quick answers. The less time we have to respond, the more influence an anchor will have on our answers.
In general, psychological anchors do not respond to variables that are too important and the markets are not alien to this type of phenomenon. As stated by Robert Shiller in Irrational Exuberance (2000): “People do not even know to any degree of accuracy what the “right” level of the market is: not many of them spend much time thinking about what its level should be or whether it is over- or underpriced today”.
What can generate these anchors?
The answers are all out there, we just need to ask the right questions.
What can generate these anchors? We will not find the answer in management, finance or economics, so we have to help ourselves from psychology to understand it.
To answer this, let’s start by thinking that it is very likely that you consider a number on your birthday to be your lucky number, or use it as part of a password, although it is not recommended. It is also quite likely that if you find coherence in a story, precisely in its cause and effect relationship, you end up believing it and saving it in some sector of your head. We talked about the latter in the article Skill vs Luck (part 1), it is what some authors call Narrative Fallacy.
Do Psychological Anchors fit within Rationality in the Markets?
Belief in the rationality of markets starts to sound a lot better when the only alternatives are such pop-psychological theories
Let’s remember that economic theory assumes that markets are efficient and actors are rational. This is, in very simple terms, the theory of the rationality of markets. However, for years the asymmetries of the markets have been studied and demonstrating the irrationality of the actors.
Robert Shiller (2000) indicates “in considering lessons from psychology, it must be noted that many popular accounts of the psychology of investing are simply not credible”, adding that “belief in the rationality of markets starts to sound a lot better when the only alternatives are such pop-psychological theories”.
In the popular perception, the media and the entertainment industry also have a responsibility, sometimes reaching the masses with incorrect messages. With productions such as “The Wolf of Wall Street” (Scorcese, 2013), the belief is that “investors are said to be euphoric or frenzied during booms or panic-stricken during market crashes. In both booms and crashes, investors are described as blindly following the herd like so many sheep, with no minds of their own” (Shiller, 2000)
The truth is that, during extreme financial events, such as big drops or rises, most of us worry more about our own problems or issues and not about market fluctuations. For most, these events are not charged with emotions, compared to others such as wars or natural catastrophes. For example, right now, in the middle of the Coronavirus Crisis, are you more concerned with the stock market or with your own affairs?
Thus, “it is hard to imagine that the market as a whole reflects the emotions described by these psychological theories” (Shiller, 2000)
Emancipate yourselves from mental slavery, none but ourselves can free our minds!
It is clear that there are psychological anchors in the market. The positive is that there is serious psychological research that has shown that there are patterns of human behavior that affect the market, generated both in the weaknesses and strengths of people. Shiller (2000) tells us that “investors are striving to do the right thing, but they have limited abilities and certain natural modes of behavior that decide their actions when an unambiguous prescription for action is lacking“.
Anchors direct our attention and affect our decisions and choices. Advertising is full of elements that generate anchors in people, such as some slogans that have been put in ads – and that many people repeat without question – most of the offers or discounts and the typical ad saying “buy 3 & pay 2”. However, as we tell you, in finance there are also psychological anchors, such as the prices at which you decide to buy or sell shares, the interest rates that you accept or reject when requesting a loan, etc. In a negotiation, the first numbers that appear are also a form of anchor. We can continue talking about examples or cases, but we will leave it for another time.
There are basically two types of psychological anchors: quantitative and qualitative. Quantitative anchors make people determine a number to decide if the value of something is “correct”. Qualitative anchors make people justify their actions emotionally.
We are Steering Bird, online advisers in direction, management and finance. We specialize in business analysis, control and analysis of investment projects, results analysis, processes of budget and forecast, etc.