While there have been a great deal of experiments to study the effects of anchoring and it’s causes, we will talk about two that I found extremely interesting.
The Wheel of Furtune
In 1974, Amos Tversky and Daniel Kahneman conducted a study in which they asked students how many African countries were included in the United Nations. The duo began by spinning a Wheel of Fortune, and not just any, it was rigged to land on either 10 or 64 out of 100. Once the number hit, the students were immediately asked whether they thought the percentage was higher or lower than the number that the wheel landed on. They then placed their vote on what they actually thought the real percentage was. The group that was exposed to the 10 guessed the percentage was around 25 percent, while the group exposed to the 65 averaged their guesses around 45 percent. The anchoring effect had done it’s work in spectacular fashion.
Surely they would realize a Wheel of Fortune (much less a rigged one) would not offer them any information regarding the percentage of the U.N. that was made up of African countries? This leads us to one more experiment on the effects of anchoring.
Rolling the Dice
A large group of Judges in Germany, all with over 15 years of experience, were given the same fake case in which a woman was caught shoplifting. Before they were asked how long the sentence she would receive was, they were to roll a dice that was loaded to roll a 3 or 9. Yes, you probably have an idea of where this is going. Upon it landing they were immediately asked whether her sentence should be lower or higher than the number they had rolled. The Judges that rolled a 3 had an average sentence time of 5 months, while the Judges that rolled a 9 had an average sentence of 8 months for the exact same case. So I’m aware that last section was not uplifting to read in the slightest; however the first step to solving a problem is acknowledging it. If these experienced Non-Biased professionals can fall prey, then we certainly can as well. As Traders, we can have a tendency to base far too much importance on where we enter our trades. We should realize, especially those of us that follow the Market Maker’s Business Model, that where we get into the Market has very little to do with how and where the Market is moving. This problem can also arise as we try piece together the signals we are seeing. We can easily get stuck on one specific move, or reference point, and it becomes near unshakable even as countering information is revealed to us. A bad entry does not mean that you are in a bad trade. While you should still focus on nailing your entries to limit risk, time to time you have to ride a trade negative more than you would like.
How to deal
The most effective way to deal with Anchoring in your trading is to approach the Market at “Delta”. This means to be centered in your thinking. The effect of anchoring can be far stronger if accompanied with intense emotions, so keeping a cool head definitely helps. In the event that you find you are basing too much emphasis on something when trading, simply ask yourself, “Am I Anchoring on this point right now, and if so, why?”. Expending mental energy towards the subject can drastically reduce it’s hold on your psyche. A final technique is more physical than mental. Place your trade, then allow yourself to get up and work on another task for a short while before you check up on your position again. Letting price move away from your anchor point can offer a clear perspective of the trade. If you love it, set it free type of thing.
These are just a few tips to keep upright in Trading specifically, but I would encourage each of you reading this to do your own research on the subject. What you will come across could be an eye opening view of how we are wired to think. The next few Blogs that I will be writing will be focused on the points surrounding Cognitive Biases in Trading. So if you are not subscribed be sure to do so! If you are interested in learning more about the Market Maker’s Business Model click HERE.
Thanks for reading.
Director of Smart Money Course