When We start with something, then we are getting sure of it and venture into unfamiliar territory from there. When we have a problem and we do not know the answer then we start thinking of what we know about the problem and then start moving towards the answer. By this, we can reach approximately nearer to answer.
If you consider how much you should pay for a house, you will be influenced by the asking price. The same house will appear more valuable if its listing price is high than if it is low, even if you are determined to resist the influence of this number.
Our mind makes some number or information as a base and makes further decisions. This effect is known as an anchoring effect. People adjust less (stay closer to the anchor) when their mental resources are depleted, either because their memory is loaded or because they are slightly drunk. Insufficient adjustment is a failure of a weak or lazy System 2.
When we go for a bargain while purchasing products/services then we got anchors with the initial listing price by the seller.
We also get anchored by numbers. When we have seen some product/service which values at Rs.10 and then if that things available below it then we rush to buy it by considering it has become cheaper.
The selective activation of compatible memories explains anchoring: the high and the low numbers activate different sets of ideas in memory.
The situation in which we are that priming to anchoring to specific numbers. For example, if someone asks us the average temperature of India and the answer is very with whether in which we are. Summer will tend to bring average temperature answers to higher temperatures and winter will bring down average temperature answers.
Investment – When we have seen the price of shares at some number then our mind gets attached to it. When the price moves lower from that previously seen price then we consider it as cheaper and buy it. Works with the stock market, when we intend to buy any equity, we got anchors with the previous prices and make decisions according to it rather than going for the absolute value of the stock which we want to own. We do not focus on the fundamental value. When we have seen stock price at Rs.100 and it has fallen to Rs.50, we tend to run for buying that stock as it has become 50% cheaper from what it tends to be. But we do not think that it may be possible that there may be any reason behind this fall in price. We easily get anchored with the numbers and then we start thinking around that numbers.
We just think of price, do not think of value or fundamentals of business. So that we should not focus on prices rather just have to focus on business, fundamentals, and value. We should keep adjusting the fundamental value of the company and does not keep anchoring with the stock price. If we cannot able to do it properly then we have to face a loss in the future also.
When the market is in a bull phase, people are ready to buy companies that are traded at higher valuation multiples. But opposite to it, when the bear phase comes, people want to pay lower valuation multiples.