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How news, info have an impact on stock prices

Loss aversion, hindsight, anchoring, confirmation and illusion of control are some of the biases that cause havoc to decision-making abilities of the investors

How news, info have an impact on stock prices

How news, info have an impact on stock prices

On any given day, we find multiple news headlines expressing some or other concern. These range from macro news to the local news that have some or other repercussions. And some of these could have a material impact on the stock prices, irrespectively, most of the news has impact on the psychology of the investors. So, it's the collective emotions of the investors that drive the markets, either up or down.

When human emotions come to play, invariably various biases roll-in, bringing volatility to the markets. It's said that we are our biggest enemies in our lives with our prejudices and residual biases cause havoc to our decision-making abilities. Thus, it requires greater introspection and observation on our own past decisions to understand our behaviour at times. This elevates our memory in recollecting the contextual actions.

There are many biases and the most common of them all are: loss aversion, hindsight, anchoring, confirmation and illusion of control. When one gets affected by losses than gains, it's a sign of loss aversion bias, per the behavioural finance. Typically, investors in such cases, sell the winning investment early while holding on to losses for longer. They believe that by holding for longer, they could recover the notional loss incurred.

This is because for the same quantum of outcome, investors feel twice the pain than the gain. One could overcome this by avoiding short-termism affecting their judgment. Another common investor behavioral pattern is hindsight bias. Market, at times, gives successful returns to the investors. Yes, it could be due to their own research and efforts.

But these investors carry their past success to extrapolate into future adding overconfidence to their behavior. This could lead them to take riskier bets beyond their comfort zone or risk appetite thinking to achieve past performance or returns. Being honest to oneself and rationally evaluating the past success could overcome this bias.

Also, a journal clearly describing the steps in the decision-making process helps them to know if the success was pure luck or meticulous planning. This helps in making better conclusions in the future too.

Anchoring bias is that investors rely too much on the first piece of information that's received or provided. When planning or making estimates, the investors tend to interpret any new piece of information from the reference point, an anchor, instead of looking at it objectively. This, hence, skews the judgement preventing one to make an informed decision. Usually, investors are fixated to a particular price of the stock and make it an anchor to make a purchase or sale of the security.

This is ubiquitous and highly prevalent but still could be controlled falling prey to this bias. One should be evidence-based in approaching the valuation and thus finding the price of the security. The easiest way is to disprove the thesis of the anchor itself i.e., list out reason on why that price is incorrect to the current context.

Investors generally either scout for information or filter available information to support their view about the market or stock or a situation. This filtration distorts the available or new information that bolsters the already understood view or perspective of the investor. This leads to herd mentality where investors end up buying stocks in on the rise, even ignoring fundamentals. To overcome this bias, one must be open-minded and receptive to opposing views.

Many investors believe that they could control the outcome and even affect the outcome though in reality, it's not true. This is particularly true with traders who do positional calls of buying and selling assuming that they are in control of their investments. This is known as illusion of control bias in behavioral finance.

Statistics, however, show that it's only minority of traders who end up making profits while trading. By keeping their investment horizons to long-term, one could overcome this bias. As one acknowledges that the volatility associated in the short-term is also part of the long-term investing strategy, this bias could be conquered.Most of the cognitive biases are subconscious in nature and one wouldn't be completely aware if they are subjected to it. The best way to avoid these biases is to remain objective, open-minded and keep a journal of decision-making process.

(The author is a co-founder of Wealocity, a wealth management firm and could be reached at [email protected])

K Naresh Kumar
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