Anchoring

Deeper Explanation

Anchoring is one of the most widely documented and counterintuitive cognitive biases. In classic experiments, Kahneman and Tversky showed that even irrelevant numbers — a randomly spun wheel of fortune showing "65" — influenced subsequent estimates of quantities like the percentage of African nations in the United Nations. People anchored to the arbitrary number and adjusted from it insufficiently. In financial markets, anchoring operates through several specific reference points. The purchase price anchor causes investors to think about a stock's performance relative to what they paid, rather than relative to its current intrinsic value. A stock bought at £100 and now trading at £60 "needs to get back to £100" — but this is not an investment analysis, it is an anchored recovery target that has no bearing on what the stock is worth or where it is likely to go. The 52-week high anchor causes investors (and analysts) to think about a stock's "potential" relative to its recent high — often setting price targets at or near prior highs without fundamental justification. A stock trading 40% below its 52-week high may be cheap or expensive depending on its intrinsic value, not on the arbitrary number of its prior high. Earnings anchor: when a company has historically earned £2 per share, analyst forecasts cluster near £2 even when the business is demonstrably changing. The adjustment from the anchor is insufficient — a pattern that explains why earnings estimate revisions tend to cluster in the same direction for multiple quarters, as analysts gradually revise toward the new reality rather than jumping immediately. The corrective for anchoring is to identify the anchor before making an analysis and to consciously consider an alternative starting point. "What would this be worth if I'd never bought it?" removes the purchase price anchor. "What does a fundamental model say this is worth?" removes the price-based anchors.