Financial markets are not just about numbers and charts; the human mind also plays a significant role. One of the psychological traps that often captures traders is Anchoring Bias. This bias occurs when the mind becomes fixated on a specific number or price level, and all subsequent decisions are based solely on that reference point.
The cost of this attachment can be high: staying too long in losing trades in the hope of a price rebound, or exiting profitable trades too early out of fear of losing gains.
- Anchoring bias causes traders to adhere too closely to their entry price and overlook new market realities.
- This bias can lead to holding losing trades for too long or exiting winning trades too early.
- Collective anchors (such as psychological levels in Bitcoin or gold) are stronger and can influence the overall market behavior.
- Using a trading journal and relying on objective data analysis are the most effective ways to uncover this bias and mitigate its impact.
What Is Anchoring Bias?
Anchoring bias, also known as the Anchoring Effect, is a well-documented cognitive error in trading psychology. In this state, a trader becomes fixated on an entry price or a specific psychological level and builds all analysis and decisions around that point, even if new market data suggests a different outlook.
Example: Imagine a trader who bought Bitcoin at $45,000. Despite negative news and falling demand indicating a possible drop to $40,000, the trader still waits for the price to return to the initial entry level. This mental fixation can lead to significant losses.
How Does Anchoring Bias Affect Financial Decision-Making?
In financial decision-making, the human mind often clings to an initial reference point such as the entry price or a past forecast, instead of focusing on new data. This Anchoring bias reduces flexibility and can lead traders to make decisions that result in losses.
The Impact of Anchoring Bias on Setting Buy and Sell Prices in the Market
One of the most common effects of anchoring is valuing an asset based on the entry price. Instead of assessing the current market trend, the trader continues to use the initial purchase price as the benchmark.
Example: A trader buys a stock at 1,000 $. When the price falls to $ 800, they refuse to sell because their mind is anchored at $ 1,000. This fixation exposes them to further losses. On the other hand, if the price rises to $ 1,100, they might sell too early and miss out on additional upside.
Market Psychology and Collective Behavior Reinforcing Anchoring Bias
Anchoring isn’t always an individual phenomenon; sometimes, a price level becomes a collective anchor. When most traders fixate on the same number, the market naturally treats it as a reference point. This effect intensifies in high-volatility environments, where crowd behavior amplifies the anchoring effect.
Example: In recent years, the $20,000 level in Bitcoin became a primary psychological anchor. Regardless of fundamentals or technical signals, many traders focused only on this level. As a result, Bitcoin’s price showed repeated volatility near this zone.
As Investopedia explains, anchoring bias can be strategically used in sales and price negotiations. By setting an initial price point, you establish a reference that can steer the rest of the discussion in your favor.
The Role of Anchoring Bias in Short-Term vs. Long-Term Trading and Its Risks
The risks associated with anchoring vary depending on the trading style. In short-term trading (scalping or day trading), it causes traders to ignore immediate technical signals and stick to a fixed number. In long-term investing, anchoring makes investors cling to their entry price or initial forecast, even when market conditions change drastically.
Example: A trader buys EUR/USD at 1.10 during a volatile session. Despite clear bearish signals, they refuse to close the position, suffering heavier losses. In the long run, an investor who bought oil at $100 in 2014 waited years for a rebound, missing opportunities to reallocate capital to more profitable markets.
Causes and Mechanisms of Anchoring Bias
Anchoring bias occurs when the mind relies on a reference point to simplify decisions, while ignoring new data —a mistake that can trap investors in volatile financial markets.
The Role of Cognitive Processes and Individual Psychology in Creating Anchoring Bias
A major driver of anchoring is the mind’s natural tendency to “cling” to initial information. Humans are inherently uncomfortable with uncertainty, so they give greater weight to the first piece of data they encounter and use it as a baseline. In psychology, this mental shortcut is referred to as a heuristic.
Example: An analyst predicts that the price of oil will reach $100. A trader who hears this number unconsciously anchors it in their mind. Even if demand indicators decline and the probability of a price drop increases, the trader continues to make decisions around that $100 figure.
The Impact of Initial and Incomplete Information on Anchoring Bias
Anchoring doesn’t always come from in-depth analysis; sometimes, incomplete information or even rumors can shape decisions. When a person has limited data, they tend to give excessive weight to that initial piece of information while ignoring new realities.
Example: An investor hears that “a certain coin grew 500% last year.” Without checking the current market or the project’s fundamentals, they expect the same growth to repeat. This reliance on incomplete data can put them at high risk, ultimately leading to significant losses.
Some automated trading algorithms exploit traders’ anchoring bias. By creating a fake anchor, they rapidly push the price to a specific level, causing traders to fixate on that point and make biased decisions.
The Difference Between Anchoring Bias and Other Cognitive Biases
There are many cognitive biases in trading psychology, each capable of distorting decision-making in different ways. Anchoring bias is one of the most significant biases, but it has distinct characteristics that set it apart from other types of biases.
Anchoring Bias vs. Confirmation Bias
Anchoring bias influences decisions by tying them to an initial number or reference point, while Confirmation Bias prompts individuals to seek out information that supports their existing belief or decision, often ignoring evidence that contradicts it.
Example:
- With Anchoring bias, a trader who bought a stock at $1,000 continues to base decisions on that price, even if market trends have shifted.
- With Confirmation Bias, the same trader pays attention only to positive analyses or news suggesting the stock will return to $1,000, while disregarding negative signals.
Anchoring Bias vs. the Framing Effect (H3)
The framing effect is about how information is presented, not the number itself. A single situation framed in different ways can lead to very different decisions. Anchoring, by contrast, is strictly about fixation on an initial figure.
Example:
- With anchoring bias, a trader who bought Bitcoin at $45,000 builds all subsequent decisions around that price.
- With the framing effect, if told there’s a “70% chance of profit,” the trader may enter the position, but if the same opportunity is described as having a “30% chance of loss,” the trader might avoid it and invest elsewhere.
| Feature | Anchoring Bias | Confirmation Bias | Framing Effect |
|---|---|---|---|
| Basis of the Error | Reliance on an initial number or reference point | Seeking information that confirms a pre-existing belief | The way information is presented or framed |
| Example | Insisting on an initial entry price for a stock | Focusing only on positive news and ignoring negative signals | Making different decisions based on a "70% success rate" versus a "30% chance of failure" |
| Main Focus | Initial number or price | Prior belief or decision | Presentation of information |
| Consequence | Holding onto losing trades or exiting profitable ones too early | Reinforcing false beliefs and lack of flexibility | Illogical decisions based on how a situation is framed |
Methods for Identifying and Managing Anchoring Bias
Anchoring bias is a mental trap that traders often don’t recognize. Signs include sticking too closely to the entry price or ignoring new market data. By identifying this bias and applying mental exercises, analytical tools, and external feedback, traders can reduce its impact.
Mental Exercises to Reduce Dependence on the Initial Anchor
The mind is like a muscle; it can be trained to make more rational decisions. A helpful exercise is scenario rewriting: ask yourself, “If I were entering the market right now, what decision would I make?” This simple question helps release fixation on the entry price or initial information.
Keeping a trading journal and documenting the reasons for entries and exits also makes it easier to spot mental biases later.
Example: A trader who bought a stock at $2,000 and sees the price drop to $1,800 can ask, “If I were entering today, would I still buy?” It helps them act more logically and avoid unnecessary stubbornness.
Using Data Analysis and Technical Tools for Rational Decisions
Relying on objective data is the best defense against mental errors. Technical tools, such as Moving Averages (MA), RSI, or support and resistance levels, ensure that decisions are made based on actual market behavior, rather than mental anchors. Analytical software and backtesting strategies also give traders a more realistic perspective.
Example: If a stock price falls below the 50-day Moving Average, it’s a bearish signal even if your entry price is higher. In this case, selling is more rational than waiting for the price to climb back to your entry level.
In trading psychology, many traders unconsciously accept the first analysis from an influential analyst or market influencer as a mental anchor. This anchoring bias often prevents them from properly adjusting to new market data, leading to poor trading decisions.
Consulting a Team or Independent Sources to Reduce Personal Bias
Sometimes the best way to counter anchoring bias is by hearing other perspectives. When a trader fixates on a number, their view narrows. Consulting with a trading team, a financial advisor, or reviewing independent analysis can broaden their perspective.
Example: A trader who bought gold at $1,950 refuses to sell at $1,900. Consulting an independent analyst who expects further declines based on fundamental analysis and technical analysis may help the trader break free from the initial anchor and manage risk effectively.
Conclusion
Anchoring bias is one of the most dangerous mental traps in trading, capable of turning a profitable strategy into a losing one. Traders who rely too heavily on their entry price or initial information lose flexibility, making decisions based not on market reality but on a mental reference point.
Overcoming this bias requires awareness, practice, and discipline. By using tools such as a trading journal, objective data analysis, and seeking independent opinions, traders can gradually learn to distance themselves from mental biases and anchors. Risk management, flexibility, and adapting to market changes are the three key factors that can help overcome this bias.
