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Anchoring (heuristic)
Anchoring is a particular form of priming effect whereby initial exposure to a number serves as a reference point and influences subsequent judgments about value. The process usually occurs without our awareness (Tversky & Kahneman, 1974), and sometimes it occurs when people’s price perceptions are influenced by reference points. For example, the price of the first house shown to us by an estate agent may serve as an anchor and influence perceptions of houses subsequently presented to us (as relatively cheap or expensive). These effects have also been shown in consumer behavior whereby not only explicit slogans to buy more (e.g. “Buy 18 Snickers bars for your freezer”), but also purchase quantity limits (e.g. “limit of 12 per person”) or ‘expansion anchors’ (e.g. “101 uses!”) can increase purchase quantities (Wansink, Kent, & Hoch, 1998). (extract from "The Behavioral Economics Guide 2015", A. Samson, D. Ariely, p. 28)
Applying the concept of Anchoring further to Trend Strategies, I would like to draw attention to the short article on blog.aphaarchitect.com: There it is mentioned, that in “Demystifying Managed Futures,” by Brian Hurst, Yao Hua Ooi, and Lasse Heje Pedersen, the authors argue that the returns for even the largest and most successful Managed Futures Funds and CTAs can be attributed to momentum strategies. They also discuss a model for the lifecycle of a trend, and then draw on behavioral psychology to hypothesize the cognitive mechanisms that drive the underlying momentum effect. Below is a graph of a typical trend:
Graph source and text extract above/below: http://blog.alphaarchitect.com
Short remarks on the Under-reaction phase (incl. the heuristic ANCHORING):
Adjustment and Anchoring. This occurs when we consider a value for a quantity before estimating that quantity. Consider the following 2 questions posed by Kahneman: Was Gandhi more or less than 144 years old when he died? How old was Gandhi when he died? Your guess was affected by the suggestion of his advanced age, which led you to anchor on it and then insufficiently adjust from that starting point, similar to how people under-react to news about a security. (also, Gandhi died at 79)
The disposition effect. This is the tendency of investors to sell their winners too early and hold onto losers too long. Selling early creates selling pressure on a long in the under-reaction phase, and reduces selling pressure on a short in the under-reaction phase, thus delaying the price discovery process in both cases.
