A crypto portfolio can perform well when traders actively guard against anchoring bias, a subtle yet significant psychological threat that can unknowingly influence their investment decisions and strategies.
It’s December 2024, and Bitcoin has hit a remarkable $100K, much to the surprise of naysayers. The market is buzzing with excitement as everyone tries to seize the moment. But let’s be real—not everyone will make enough for that dream lambo. In fact, many might not even see a profit and could face losses.
Investing in crypto and trading can be exhilarating, offering plenty of chances to grow your wealth. However, the complexity and volatility of the market can also bring significant risks, especially for those who aren’t careful. One risk is anchoring bias—a tendency to rely too much on the first piece of information (the “anchor“) encountered when making decisions. This bias might seem harmless but can wreak havoc on a crypto portfolio if not managed.
In this article, we’ll learn what anchoring bias is, share examples of how it can damage one’s portfolio, and provide practical strategies to avoid it, especially for those new to investing in crypto tokens.
What is anchoring bias?
Anchoring bias is something we all experience. It’s when we cling to the first piece of information we hear and let it shape our decisions. Think of it like a mental anchor that influences our judgment, even if it’s not accurate or relevant.
Imagine someone tells you XRP will soon hit $5. That number might stick to your mind, and even if things change or you hear new info, it can be hard to let go of that initial figure.
This bias can be particularly risky. Prices can swing wildly, and if you rely too much on one piece of information, it might lead to some not-so-great decisions.
Examples of anchoring bias in crypto
1. Clinging to high price goals
Imagine you excitedly buy Ethereum (ETH) at $2,500, inspired by a prediction from your favorite crypto YouTuber or your paid-crypto analyst that ETH will reach $10,000 by year’s end. This optimistic forecast becomes your guiding belief.
As ETH rises to $4,000, you’re thrilled but hold on, convinced that $10,000 is just around the corner. However, when the market turns bearish and ETH’s price starts to decline, you cling to that $10,000 expectation, missing the opportunity to sell at a profit.
Eventually, ETH falls back to $1,000, and you face a disappointing loss. In this scenario, the $10,000 prediction anchored your expectations, blinding you to shifting market trends and the chance to secure profit from the initial price growth.
This is something many crypto traders and investors have experienced, and I went through it too when I first got into crypto. Back in late 2017 through 2018, I invested heavily in crypto. However, as the market turned bearish, I found myself clinging to the information I had about the tokens’ fundamentals while overlooking the broader market risks and sentiments.
2. Trusting initial low prices of coins can be misleading
Imagine you’re comparing two tokens, token A and token B. Token A is priced at $50, while Token B costs just $0.01. At first, you might think Token B is a hidden gem, a potential winner, because its low price suggests it could increase in value.
But this initial impression can be misleading, as it overlooks important factors like the total supply or market capitalization of each token. Token A might have a limited supply, which makes each unit more valuable, whereas Token B could have billions of tokens available, reducing its value despite the seemingly cheap price. The low cost of Token B might not translate into better returns if the market conditions don’t support its growth.
3. Anchoring to past highs
Imagine buying Bitcoin at $50,000 in 2021, thinking it will surely climb back to its previous peak of $65,000. This hope, anchored to past highs, might make you hold onto it even as the price falls to $30,000, $20,000, or even lower.
The reluctance to sell comes from a strong belief that it will bounce back to its former glory. Many crypto traders experienced this during the 2017/18 downturn when Bitcoin plummeted to around $3,000.
4. Trading based on the tokensale price
When you saw a token at an initial price of $0.05, and now, seeing it at $4.00 – 80x, it might feel way too pricey because you’re stuck thinking about that original price. This way of thinking can make you overlook potential profits, especially if the token’s underlying value supports its current and future price.
It’s common to hear people say a token has already done 100x, so there’s little chance of it surging another 10x. That’s why Dogecoin’s 2021 price surge surprised many.
How anchoring bias can destroy a portfolio
Anchoring bias in investing can lead to missed opportunities, emotional decisions, over-allocation to risky assets, and ignoring fundamentals. This cognitive bias can prevent traders from entering or exiting the market at optimal times, as they may cling to unrealistic price targets, resulting in losses or missed profits. Emotional reactions such as fear or greed can be triggered by anchoring. Traders anchored to high price predictions may hold assets out of greed, while those anchored to past lows might panic sell due to fear.
Additionally, anchoring can lead to overconfidence in particular tokens, prompting traders to allocate an excessive portion of their portfolio to a risky asset based on early success. This overallocation can result in huge losses if the asset underperforms. Again, focusing on an anchor can distract traders from critical factors like project fundamentals, market conditions, and their overall investment strategy. A personal experience highlights this issue: from 2017 to 2018, considerable losses were incurred on an investment in TRX due to anchoring to a hopeful analysis, while ignoring prevailing market sentiment.
How to avoid anchoring bias in crypto
The good news is that anchoring bias is avoidable with awareness and discipline. Below are strategies to help newbies and experienced investors alike:
1. Diversify your sources of information
Do not rely on a single source of information. If you always follow one influencer or analyst, try to gather information from multiple reputable sources to form a well-rounded view. This reduces the likelihood of one perspective dominating your decision-making process.
For example, if one influencer predicts Bitcoin will hit $200,000 and another forecasts $80,000, evaluate both perspectives critically. Consider factors such as macroeconomic conditions, market sentiment, and historical trends.
2. Focus on fundamentals
Always base your investment decisions on solid fundamentals rather than arbitrary price points. Assess the project’s use case, team, adoption potential, and competitive landscape. For instance, instead of fixating on SOL’s previous all-time high, focus on its role in DeFi, NFTs, and memes to determine its potential value. These three sectors are known to significantly influence the price of L1 and L2 native tokens.
3. Use stop-loss and take-profit strategies
Setting stop-loss and take-profit levels helps remove emotional bias from decision-making. These predetermined exit points ensure that you stick to your plan, even when anchored to specific price targets.
For example, if you buy a token at $100, set a stop-loss at $90 and a take-profit at $120. This compels you to act rationally, regardless of anchoring bias.
Read also: How to Protect your Crypto Trading Portfolio
4. Question your assumptions
Before making a trade, ask yourself, “Why do I believe this?” If your reasoning is based on an arbitrary number or someone else’s prediction, pause and reconsider. Always justify your decisions with logical and evidence-based arguments.
5. Maintain a long-term perspective
The crypto market is notoriously volatile. Anchoring to short-term price fluctuations can cloud your judgment. Instead, you focus on long-term trends and the broader adoption of blockchain technology while taking advantage of short-term opportunities.
For example, instead of obsessing over Bitcoin’s daily price swings, consider its role as digital gold and its growing adoption by institutional investors. History has shown, especially after halving, that Bitcoin prices always surge to new all-time highs. Having a long-term perspective changes how you see daily price actions.
6. Don’t be overconfident
Recognize that no one can predict the market with certainty. Overconfidence often amplifies anchoring bias. Be humble, and be prepared to adjust your strategy as new information becomes available. Be flexible.
7. Educate yourself continuously
The more you understand the market, the less likely you are to fall prey to biases. Learn about market cycles, technical analysis, and behavioral finance to build a solid foundation.
8. Practice mindfulness and emotional control
Investing often triggers strong emotions, which can exacerbate bias. Techniques like meditation, journaling, or simply taking a break before making critical decisions can help you stay grounded.
A path to success
The recognition and address of anchoring bias can make you more informed and make rational decisions, paving the way for long-term success. Remember, the crypto market is unpredictable, and anchoring to a single piece of information—whether it’s a price prediction, past high, or IDO price—can blind you to reality.
Instead, focus on developing a robust strategy, staying flexible, and continuously educating yourself. You’ll not only avoid the pitfalls of anchoring bias by doing this but also position yourself to thrive in the fast-paced crypto market.
