We use mental shortcuts (heuristics) to make decisions rapidly. These work in many circumstances, but when it comes to investing, they can be a major handicap, giving rise to "cognitive biases".Key examples include the following:
Anchoring: the tendency to "anchor" to a piece of data we are exposed to while making a decision, regardless of pertinence. For example, in a 1974 study, Kahneman and Tversky asked subjects to write down the last three digits of their phone numbers, multiplied by 1,000. They were then asked to make estimates of house prices. The higher the phone number, the higher the estimate. In investing, anchoring can, for example, tempt you to buy a stock that has fallen after a profit warning, because you have anchored'' to its previous price and see it as a bargain, disregarding the deterioration in its fundamentals.
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