Behavioral Crypto #1: Anchoring - Understand Your Brain and Get Rich!

Hey all,

Today I'm excited to present you with my first of a multi-post series on Behavioral Crypto! My hope is that with each post you will gain new tools allowing you to take your investment game to the next level. If you follow along carefully and are willing to learn more about the way your brain influences your investment decisions, I can guarantee that you will decrease the number of negative-return investments you make and increase your profits.

For those of you who don't enjoy reading financial textbooks (I don't blame you!), I borrowed the name Behavioral Crypto from an exciting branch of finance called Behavioral Finance. As you probably know, crypto-currencies trade in much the same way as stocks do, which means that we can apply some stock investment principles to cryptos – which is exactly what I set out to do here. Behavioral finance is especially relevant to cryptos because of how volatile the crypto market is, and of how imperfect the available information is.

So, what is Behavioral Finance?

Simply put, Traditional Finance operates on assumptions which almost never manifest in the real world. Behavioral Finance relaxes these assumptions and tries to explain market events by looking at human psychology. Behavioral Finance helps us understand our human behaviors and biases and how they affect our investment decisions. It's quite a fascinating field because it's a hybrid between psychology and finance, and its mastery will give you a serious advantage over other market participants.

In order to keep these posts bite-sized and easily digestible, I will discuss one important behavioral issue in each post. I highly recommend checking all of them out and using your new-found knowledge to increase your riches =)

Now, let me introduce the first of our biases:

Anchoring

Anchoring is an important psychological bias to be aware of as it appears in many facets of life. It can be used as a powerful tool in marketing or in negotiations, but it can also play tricks on us if we are not aware of its existence. Let me begin by introducing anchoring to you in its most simplistic and familiar form: marketing.

Let's say you're at the store looking to buy some headphones and the two items below represent your only two options. Let's also imagine that both pairs look to be almost identical. Which pair are you going to pick?

It's almost guaranteed that you will pick the headphones that were originally priced at $89.99, and why wouldn't you? You're obviously getting way more bang for your buck... Or are you?

The problem in this situation doesn't necessarily lie with your final decision, be it to buy one or the other pair of headphones. The problem here is that you will almost certainly buy the pair on sale without digging much deeper. After all, if people usually buy them for $89.99, they must surely be of higher quality than the $39.99 pair. But what if they aren't?

Now imagine that the sale price was not $39.99, but $49.99; how, if at all, would your decision making change? Would you rationalize paying an extra $10 over the price of the cheap pair to get an extra $50 worth of value? I bet you would. And that is the power of anchoring.

In many situations, people end up paying more for the exact same product, or even a shittier version of a product, just because of anchoring. The truth is that the company is happy selling it to you at the sale price. They're not doing you a favor at all, they're tricking you into buying their product by making you feel like you are getting a good deal.

I'm sure you can see how anchoring would be a powerful negotiating technique as well. In fact, I can almost guarantee you have used it at one time or another in your life. Whatever the situation may be, by initially demanding more than what you actually want, it becomes easier to get what you want from the other party.

So, now that we clearly understand the power of anchoring, let's take it back to investing. How might it apply to your investments in cryptos? Well, let's look at the two coins below following a few days of bloodshed in the market.

Which one looks more attractive? Well, if you let your anchoring bias have the best of you, I can guarantee that you will see Super Awesome Coin as being undervalued at the moment compared to Awesome Coin. Your first instinct will be to think that if the market is about to rebound, Super Awesome Coin is more likely to jump higher since it was trading for way more than Awesome Coin before the market took a downturn. What you are doing here is using the previous high-price of SA Coin as your point of reference, your anchor.

Now that might work out some of the time. But if you want to maximize your investment returns, you need to make sure that you are fully in control of all your decisions. What if you put your money in SA Coin thinking you're about to make a quick buck on the rebound, when in actuality Awesome Coin is about to see a huge up-move, and SA Coin is going to keep heading south after previously announced developments failed to materialize?

It may sound obvious that one should stay on top of all news and be well informed before making any trade, but the fact that there is a buyer for each seller when the price of a coin is dropping is proof enough that many people fall prey to the anchoring bias. Sure, some of those buyers might be privy to information that leads them to believe the coin will rebound nicely, but that is certainly not true of the majority of buyers, who are only attempting to cash in on a rebound which, according to the magical thought, must surely happen since the coin was worth so much more just last week!

How Do You Go About Avoiding Anchoring?

First, you want to make sure you understand what originally drove the price of a currency to its peak; was it pure speculation, or was there a driving force (such as a positive news announcement) behind the rally? Once you are able to pinpoint what led to the rally, your next task is to figure out whether or not that factor is still in play, and whether the original rally led to a reasonable market cap given the information available or if it overshot.

If you believe that the original rally was backed up by something concrete, that the market cap it reached at its peak was justified, and that there has been no setbacks since the original catalyst, then the currency might be a worthwhile investment; otherwise you might want to be more cautious and ensure there actually is some upside.

This due diligence can be harder to accomplish on cryptos than on stocks due to the scarcity of information on some cryptos; however, that's no reason to not at least do the best due diligence you can to get an idea of the amount of risk you are taking on. You might feel that some cryptos are worth investing in based on speculation only, and that's totally fine, but you might also be able to completely rule out some other cryptos once you take away your urge to ride them back to their previous highs. As we all know, managing risk is key to investment success. There is already enough uncertainty and volatility surrounding cryptos as is, you can't afford to have a negative return on an investment just because you didn't put in that extra effort.

I hope you found this post interesting and it helped you understand your anchoring bias! Please feel free to upvote and comment if you found this content useful, and be sure to resteem if you think it could also help some of your followers!

Enjoy today,

William