“Anchoring” is a strategy in behavioral finance that defines the subconscious use of useless data as a fixed reference point (or anchor) for making subsequent decisions about security.
De-anchoring, on the other hand, indicates that short-term price shocks have the potential to affect assumptions for the long term. It is important to note that the papers provide measures that might be used in the medium and near term to track this de-anchoring.
What Are Rising Interest Rates?
Interest rates are a particularly significant component of economics because of the impact they have on both the value of a stock and the amount of money we spend.
It is essential to have stable central banks in order to maintain economic activity. One method for accomplishing this goal is controlling the rates at which larger banks provide smaller banks loans at a variable interest rate during the overnight market.
These smaller banks then make loans to corporations and individuals to assist them in producing products and maintaining themselves at a higher interest rate. This is done in order for the banks to remain profitable.
In this manner, corporations have an easier way of producing more goods and selling those products while simultaneously repaying the smaller bank and earning additional interest. In a much similar approach, smaller banks pay back larger banks and pay their interest rates as well, thus maintaining the status quo and keeping the system stable.
Individuals in this situation use the loans to purchase homes or other materialistic needs and pay the smaller banks back eventually.
Central banks play a big role because their say in policy rates for the overnight market is very important to the interest rates that smaller banks give to individuals and corporations. If, let’s say, the policy rate was higher, that would mean that smaller banks would have a higher interest rate, which would affect their connections with companies and individuals.
During the 2008 financial crisis in the US, the central banks lowered their policy rates, which made the interest rates between banks, companies, and individuals lower as well. This allowed companies to have lower spending, hire more people, and sell more products.
This trend has lasted for a while now, and the central banks have finally started to increase their policy rates, meaning that soon banks will have to raise their interest rates as well.
Why Do Central Banks Raise Their Policy Rates?
Think of it this way, if the policy rate is low, that means that spending has increased. This makes the stable development level of a country go faster than it intended to.
In order to calm the situation down a bit, the central bank raises the policy rates, making the spending lower and stabilizing the country’s growth again.
When economic activity is high, that also raises the demand for products and goods from companies. Even though this looks like something positive, it is very negative to a country’s growth.
In general, since economic activity is high, the demand is higher, and so is the production, and in this same manner, so are the prices of those products and goods. This eventually leads to what is called “inflation”.
What is Anchoring?
The behavior known as “anchoring” occurs when an investor has a tendency to grow attached to information that might not be factual or useful.
For instance, a stock investor might notice that the price of a particular stock is going down. This investor may “anchor” to a recent high in the price and use the new low prices as a reason to buy additional stock for cheap, expecting that the price will climb again and that they will win more money as a result of their investment.
Hence, the price could be falling swiftly due to underlying issues; hence, they might be losing more money than they anticipated. The investor is fixated on the recent surge in the price of the stock and has become oblivious to the current market conditions, which could result in the investor suffering significant financial losses.
How Does Anchoring Happen?
Let us take an example. If a certain stock company has lost a collaboration with a major other company, their stock prices start to fall. Investors in this scenario do not see the real reason why the stock price has gone down and anchor on the recent high price of the stock.
By anchoring, which is metaphorical for stopping or holding on, to that recent high price they use that situation to buy more stock from that company at a discount price, expecting the price to go up again soon and then de-anchoring and selling.
This behavior may not always be correct. That is why investors should look deeper into the companies they have stock in. Otherwise, it will result in a loss.
How to Be Careful of Anchoring
If you decide to anchor on a recent high, make sure to not get fooled by the first bit of information you receive. Try to have reliable sources and look deeper into the stock you own and the market in general.
Anchoring may not always result in a loss, but when it does, it is a heavy loss. Making sure you are well informed about a stock and the company you hold stock in is a major role in the market.
Takeaways
- Anchoring is a strategy in behavioral finance that defines the subconscious use of useless data as a fixed reference point for making subsequent decisions about security.
- Interest rates are a particularly significant component of economics because of the impact they have on both the value of a stock and the amount of money we spend.
- Central banks play a big role because their say in policy rates is very important to the interest rates that smaller banks give to individuals and corporations.
- The behavior known as “anchoring” occurs when an investor has a tendency to grow attached to information that might not be factual or useful.
- By anchoring, which is metaphorical for stopping or holding on, to that recent high price they use that situation to buy more stock from that company at a discount price
- During the 2008 financial crisis in the US, central banks lowered their policy rates, which made the interest rates between banks, companies, and individuals lower as well.
