28 Apr Anchoring Bias Definition, Overview and Examples

Because they are so familiar with the situation, their early responses are likely to be correct. Algorithms are step-by-step instructions that lead to predictable, reliable outcomes; whereas heuristics are mental shortcuts that are basically best guesses. Algorithms always lead to accurate outcomes, whereas, heuristics do not. The representativeness heuristicinvolves making a decision by comparing the present situation to the most representative mental prototype. When you are trying to decide if someone is trustworthy, you might compare aspects of the individual to other mental examples you hold.

The anchoring bias is a type of cognitive bias in which people give too much importance to the first piece of information they learn. It is highly prevalent and can even be affected by completely arbitrary, unrelated information. It can also lead to poor judgments, but research suggests that it is difficult to overcome.

So, if two companies have the same financial profile except Company X has fewer shares at a higher price than Company Y, then Company X’s shares will sell better over the long run than Company Y’s. Because the stock price — the anchor — enhances the company’s perceived value. After all, I estimated the cost of the pasta based on the adult menu, not the actual cost of making some bow-tie noodles and serving them with a red-tinted sauce.

What Is Anchoring Bias? | Definition & Examples

For instance, traders are typically anchored to the price at which they bought a security. Comprehensive research and assessment of factors affecting markets or a security’s price are necessary to eliminate anchoring bias from decision-making in the investment process. Historical values, such as acquisition prices or high-water marks, are common anchors. This holds for values necessary to accomplish a certain objective, such as achieving a target return or generating a particular amount of net proceeds.

Understanding these biases is very helpful in learning how they can lead us to poor decisions in life. Because you can probably think of examples of bad things happening to other people it seems more likely that others will be affected by negative events. The effect of this bias is that it causes us to overestimate our ability to predict events. Heuristics are mental shortcuts that allow people to solve problems and make judgments quickly and efficiently.

One explanation of why the anchoring bias occurs is due to the primacy effect. The primacy effect is the tendency for people to remember things that they learn first better than things that they learn later on (Stewart et al., 2004). This leads to a large difference between the average estimates between the two groups, which emphasizes both the significance and the scale of the anchoring bias. Both group’s estimations were clearly influenced by their starting values. The groups both gave an uneven amount of weight to the initial value, causing their final estimates to be swayed in the direction of that initial value.

• We’re starting with a price today, and we’re building our sense of value based on that anchor.
• Also, explore some strategies you can use to avoid the anchoring bias to make more accurate decisions.
• Negative emotions, on the other hand, lead people to focus on the potential downsides of a decision rather than the possible benefits.
• Anchoring can be present with relative metrics, such as valuation multiples.
• A 2013 study confirmed this result, also finding that people in a sad mood are more prone to the anchoring bias .

In addition, they were explicitly informed that anchoring would “contaminate” their responses, and that they should do their best to correct for that. Regardless of how they were informed and whether they were informed correctly, all of the experimental groups reported higher estimates than the control group. Thus, despite being expressly aware of the anchoring effect, participants were still unable to avoid it. A later study found that even when offered monetary incentives, people are unable to effectively adjust from an anchor. Anchoring bias is a type of cognitive bias that causes people to favor information they received early in the decision-making process.

Cognitive ability

Alex tells me that he recently worked to eliminate the anchor of a counterparty whose company’s valuation had dwindled due to diligence issues. The counterparty still insisted on referring to the $500 million initial valuation in negotiations. But Alex reminded them that the number was no longer relevant and could no longer serve as a basis for negotiations. We simply don’t have the time to evaluate every thought in every decision for the presence of any bias.

This results in a diminished quality in the decision-making process and consequently, amplifies the pre-existing anchored biases. Because participants did not have enough time to calculate the full answer, they had to make an estimate after their first few multiplications. When these first multiplications gave a small answer – because the sequence started with small numbers – the median estimate was 512; when the sequence started with the larger numbers, the median estimate was 2,250.

Anchoring Bias: What It Is and How to Prevent It

Another anchoring bias meaning example is someone buying lottery tickets because the lifestyle and benefits that come with winning are more readily available in mind than the complex probability calculation of actually winning the lottery . An extension of this theory asserts that we are naturally optimistic, so negative outcomes come as a surprise and receive external attributions as a result. The leading explanation for why the self-serving bias occurs is that it is a way of protecting our self-esteem .

People may judge their relationships with someone based too much on the beginning of the relationships. A 2020 study raises the concern that doctors may fall prone to the anchoring bias when diagnosing patients with COVID-19, and therefore may fail to properly diagnose future issues that arise with these patients (Yousaf et al., 2020). When estimating something, predictors are less likely to choose an amount which is close to the maximum allowable adjustment.

Or it may prompt the anchorer to try again, this time with an anchor closer to where you want it to be. If you know a great deal about the asset up for discussion, you can make an aggressive first offer with confidence and expect that your offer will anchor the discussion to your advantage. If both sides have a strong sense of the zone of possible agreement , as in the case of a longtime relationship between a supplier and customer with open books, anchors are unlikely to have a strong impact. To test this idea, Strack and Mussweiler had participants fill out a questionnaire.

Anchoring Bias Example in Finance

Saul Mcleod, Ph.D., is a qualified psychology teacher with over 18 years experience of working in further and higher education. The Structured Query Language comprises several different data types that allow it to store different types of information… Kassiani has an academic background in Communication, Bioeconomy and Circular Economy. As a former journalist she enjoys turning complex scientific information into easily accessible articles to help students. Although all of them help us reduce the time and effort needed to form a judgment, they do so in different ways.

However, strategies such as research, critical thinking, and zero-based budgeting can help keep our thinking well-grounded. It’s even possible to understand and use the anchoring bias of others to your advantage in negotiations. Once the anchor is set, subsequent judgements are made by adjusting away from that anchor, while staying within the range set by it.

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Their later answers were influenced by whatever those initial anchor points were. Some anchors, such as absolute historical values and values necessary to accomplish an objective, can be harmful to investment objectives, and many analysts encourage investors to reject these types of anchors. Other anchors can be helpful as market participants deal with the complexity and uncertainty inherent in an environment of information overload. Market participants can counter anchoring bias by identifying the factors behind the anchor and replacing suppositions with quantifiable data.

In other words, although both anchoring and availability bias influence our perception, anchoring is related to the order in which we receive the information, while availability is related to ease of recall. This shows that under the anchoring bias, irrelevant anchors are just as impactful as anchors that offer relevant informational cues. With that amount as a starting point, you manage to negotiate up to $55,000. In reality, the HR person could have offered you more, but they used the anchoring effect against you. By starting with a low value, they influenced your perception of what an acceptable salary would be. Since your initial research indicated that $27,000 was the average price, the first offer you encountered seemed like a great deal.

Because we subconsciously place more importance on the initial value or answer we come up with, we typically fail to adjust sufficiently from there on and our judgement is biased. Incidental price is defined as the prices offered or showed by a seller for products which the consumers are not interested in. According to the theory, the incidental price serves as an anchor which increases consumers’ willingness to pay. This effect has been widely used in areas such as auctions, online vendors and retailers. Sellers usually sort the prices of products from high to low and this method is common seen on the menus of restaurants. The high prices at the top of the menu act as anchor values in this situation.

However, multiple studies have shown that initial offers have a stronger influence on the outcome of negotiations than subsequent counteroffers. Cognitive conceit or overconfidence arises from other factors like personal cognitive attributes such as knowledge and decision-making ability, decreasing the probability to pursue external sources of confirmation. This factor has also been shown to arise with tasks with greater difficulty.

Additionally, the anchoring bias may be avoided by being more experienced in a task (Welsh et al., 2014). One may therefore practice a task in order to avoid the anchoring bias in future experiences involving that task. This may suggest a role of cognitive workload within the anchoring bias.

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. The most famous study to demonstrate the inattentional blindness phenomenon is the invisible gorilla study (Most et al., 2001).

But when things turn out badly, you are more likely to blame it on circumstances or bad luck. The effects of misinformation can range from the trivial to much more serious. It might cause you to misremember something you thought happened at work, or it might lead to someone incorrectly identifying the wrong suspect in a criminal case. In one classic psychology experiment, college students were asked to predict whether they thought then-nominee Clarence Thomas would be confirmed to the U.S.