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Anchoring Bias, Survivor Bias and Hindsight Bias


Deepak says:

I entered RNRL at 29-30 levels and am still holding. I dont play pure momentum plays and this was my first. While I am still moving from booking all profits , to complete exit, to no action, I read this interesting piece about anchoring bias in such cases. So I am going back and trying to analyse before I decide about RNRL. But yeah, this last 1500 point has thrown some of my workings off track – TVS, Ashok Leyland – where I thought were long term bits, am not sure if I play the momentum and then re-enter at a later option…

This is a fabulous comment. Anchoring bias is when you cling on, irrationally, to a certain piece of information and ignoring others. This rediff article has a wonderful set of biases that you and I are prone to, and some of the explanations hit home.

For instance, someone told me they wanted to buy stock X at Rs. 500 but by the time they saw it, it was Rs. 550 and they wanted to wait. It then went to 600,700 etc. and they never bought it. The Anchoring bias strikes again. If you ‘anchored’ to a price that you had earlier seen, you will think the current higher price is too expensive.

Yet, consider this: If you thought the stock was good at Rs. 500, why is it not good enough at 550? Did you want to buy it only for 10% returns?

Another example is when you decide NOT to sell because the stock obviously can’t go below this price, since it was so much higher earlier! Or to not buy a stock again because it was way above your sell price when you last sold.

While I think I am as susceptible to anchoring bias as everyone else, I believe firmly that certain decisions should be taken blindly without asking yourself why. I sold RNRL at 87, when it slipped. It’s at 95 today, and I would still buy it again because it seems to be showing the momentum. If I sat around thinking that last month it was at Rs. 50, I would be a helpless soul.

If you think the Sensex is at phenomenal highs now, consider this: The current Sensex (Trailing 12 month) P/E is 23.45. In Jan 2007, the Sensex was at 14,000 and the P/E was 23.

In April 2000, Sensex was 5,000 and P/E was 27. In May 1995, the Sensex was at 3,000 and P/E was 28.

On the other hand, just before the huge drop in 2006, the Sensex at 12,500 had a P/E of only 21. What this means is that 17,000 alone does not determine if the Sensex is expensive – it has been far higher earlier, and even gone to 30. At today’s EPS, a P/E of 30 translates to 22,500 on the Sensex (This is before earnings season, which will start later this week, and if companies actually increase earnings the P/E will drop if Sensex stays at this leve).

And you can’t assume that just because it’s 23+ now, the Sensex will fall. As I’ve noted, it’s fallen from what was a P/E of 21 in 2006. In 2004, the Sensex fell from a 19 P/E (5,600) to a 14 P/E (5,100) in three months. Note again that the point fall is not much, but the earnings rose significantly so P/E dropped.

Just because a P/E is higher than earlier doesn’t mean it’s a bad time to buy stocks. And you shouldn’t have an anchoring bias on the VALUE of the Sensex, it has no meaning on its own!

Let’s say you bought a stock at Rs. 100. It went to Rs. 180, and dropped to Rs. 150. You decided enough was enough and sold. Now the stock zooms to Rs. 200. Will you buy? I have not met many people who will say yes (or those who’ll actually do it).

Recently, I bought NIIT Tech at 307, sold at 341 on my trailing stop loss. Then it started moving again, so I bought the future at 355 and sold at 360 for a leveraged play. In the interim, I used the money for RNRL to wiggle out about 11%. While that was higher than the 341-355 move by NIIT Tech (which was just 4%) I would still have been happy to have the money in my bank account in the interim.

Why? Because I don’t care about the price. If the stock is going up, I will buy. And I will have a stop loss if the stock doesn’t go in my direction.

One more problem is “survivorship bias”. You look at an RNRL or NIIT today both of which moved up after hitting the stop loss, but my universe consists of a large number of stocks that have gone underwater since.

For instance: Bata in 2006. I bought at 83, watched it go to 305, and sold on the way at 240. It slipped straight down to 140 and is now at 191.

Marksans pharma moved back to 48 after my purchase at 230+. I sold at 128. Today, the stock’s back up to 120 and I would buy if it crosses my buy price also (I can’t right now because it’s on upper circuit everyday, no sellers, only buyers)

And another gazillion stocks in the market. I have liked Sintex for a while and have been watching it for smart moves since it was at 200. It’s recently moved very fast and is at 360. Still worth a buy to me, but does the price scare you?

Note that survivor bias exists in the “buy and hold” investors more than anything else. People tell you – if I had invested 10,000 in 1992 in Infosys I would be a crorepati. But they don’t tell you that if they had invested Rs. 10,000 in Arvind Mills in 1992, they would be one extremely unhappy lot.

They also don’t tell you the value of 10,000 in 1992. Inflation is a sorry representation. In 1992, I had just joined college and my monthly mess fees were Rs. 300. In 1996, when I graduated, they were Rs. 900 a month. My first job paid me about 6,000 a month, but let’s take an average of Rs. 10,000 as a “good” salary at the time, and divide by three to get to what salaries would have been in ’92 – that means a month’s salary would be about Rs. 3,300. Now think about investing three months salary (which could take you two years to save) in one stock, and tell me what you woudl have chosen between Arvind Mills (the big boy of that time) or Infosys (who cared about IT stocks then?).

Hindsight is always great, but the bias you have today looking at the past does not encapsulate the fact that at that time there were a lot more choices to make, some of which have not survived till today. So when someone tells you that “if you had bought Praj Industries in 2002 for 1 lakh, you would be worth 5.2 crore today”, please tell them to take a long walk. In 2002, you probably didn’t have 1 lakh (I surely did not) and even if you did, you would have not chosen a stock like Praj which had losses and no growth outlook for the time.

We should learn to be more objective in our assessments of both stocks and commentators. Read this set of articles from about investor fallacies, which is an excellent commentary on common misconceptions, anchoring biases etc. Remember that this article was written in 199, when the “bubble” was on – but still, there are lessons to be learned anyhow.


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