Assets How your subconscious responds to market changes

As the Greek philosopher Heraclitus said: “Nothing is as constant as change.” This is particularly true of financial markets, where prices rise and fall every day. Unconscious behavioral tendencies, also called biases, cause us to react to changes on the market in certain ways. We will explain three of these tendencies in more detail to help you better understand your own behavior in the event of price fluctuations and make more well-informed, objective decisions.

When faced with a new decision, we tend to rely on information gained from previous decisions and to neglect new information. This, at least, is what conservatism bias says.

The challenge here is that those who stick to their previous knowledge and do not expand it with new insights will not be able to make well-founded decisions in the event of changes. Investors who display this behavioral tendency tend to invest more conservatively and react too slowly to trends on the financial market.

Imagine the following example: You invest in a company that specializes in reducing the CO₂ in the earth’s atmosphere by absorbing greenhouse gases. Right now, this technology is new and unique. In ten years’ time, however, a competitor could become much more established. In a worst-case scenario, failure to stay informed could mean you miss the boat. Due to outdated information, investors may be tempted to hold onto their original investment and not sell it at the crucial moment.

This conservative behavior can be traced back to the early days of humankind when people survived by repeating previous behavior. Today, the world is a much more dynamic place where repetitive patterns of behavior are often not effective, especially in volatile financial markets.

Anyone who orders something from an online shop will be familiar with the following example. There are two identical products: the first was originally priced at CHF 50 but is now on sale at CHF 20. The second product is still at the original price of CHF 20. Which product would you rather buy?

Although both products cost the same, most people will probably choose the first one. Why? Because we tend to base our decisions on the first available information. This behavior is known as the anchoring effect.

We subconsciously compare follow-up information with the previous information – it serves as a kind of anchor for comparison.

When applied to the stock market, the anchoring effect causes investors to make decisions based on the initial price of the stock and the fear that its value could drop after purchase. Selling it prematurely might lead to missed opportunities because it would be impossible to benefit from future price rises.

Do you remember when Swissair was grounded? When Switzerland’s national airline went bankrupt in 2001, many investors hoped for better times when they would be rewarded for sticking with the company. They fell prey to what is called the disposition effect.

This effect is particularly evident in an investment context and can be described by the following quote from the two economists Hersh Shefrin and Meir Statman:

The disposition effect describes a situation in which investors hold shares for too long when the price falls and sell them too soon when the price begins to rise again.

There is, of course, no right or wrong answer when investing because no one can predict what will happen on the market. Depending on the investment strategy, early profit-taking can certainly make sense. However, those hoping for long-term dividend growth with a “buy and hold” strategy will find that selling too quickly can be counterproductive.

The disposition effect is diametrically opposed to the loss aversion bias, according to which investors would sell their stocks immediately. Read more about loss aversion and other psychological biases in the field of behavioral finance in the article “Should I invest? Factors that influence our decision”.

Before making your next investment, it’s worth thinking back to these three behavioral theories and questioning your own behavior. Try to identify which behavioral tendencies – if any – affect you the most, and try to avoid them.

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