Behavioral Bias In Markets Part 3 : Availability Heuristic

Next in our series of behavioral traits that inhibit our performance is what is termed as the Availability heuristic. We always interact with the environment as well as with each other basis the information that is available to us. The Availability Heuristic refers to a common mistake that our brains make by assuming that the examples which come to mind easily are also the most important or prevalent things.
One of the most dominant elements in the lives of traders and investors is the business news channel and research reports. These two items dominate the information aspect about stocks almost completely- to the point that people will believe only what they see and hear on channels (or read in the papers) and what they read in research reports. Obviously therefore what gets covered in these are the stocks about which information is available and images and beliefs are constructed in people’s minds.

What actually happens with a stock and what actually gets reported or presented in a research report can be vastly different. For e.g. Out of, say, 100 things that may be happening with respect to a stocks just now, only 10 of those may be getting reported or covered by broker research. So, the public’s knowledge is restricted to this 10% only! They therefore tend to overvalue these ten items to the exclusion of the other 90%!!

This manifests in another way that is important for day traders. The news channel is almost completely focused on the breaking news of the day. So, if a company has declared results today that news item is played all day long, the management is called (where possible) to discuss, broking house personnel are asked to opine about the results and technical analysts are quizzed about the support and resistance levels for that stock. There is so much focus on this stock for the day that its availability heuristic quotient is extremely high. This leads to a lot more participation in the stock and hence there is also movement. People unaware of this bias acting within traders and investors believe that the stock is moving because of the news. Actually it is the wide prevalence of the news that is making it move. Suddenly that stock takes precedence over most others. We see this kind of exaggerated price action especially during results time.

Now, if there are additional stocks from that sector or genre also out with some news, the mind immediately uses those as examples and tries to connect the dots. It need not even be on the same day- something recent would be sufficient. The memory of the associated items creates a bias in the mind and the current information is viewed differently.

This is one of the reasons why most people are unable to buy during dips and sell during rallies. While a rise is in progress one is clear that a dip is to be used to buy. But as soon as prices turn around – and they normally do so on some reason- the ‘availability’ of a reason for the decline seems to get overrated in the minds of people and then they expect the fall to continue, even if they had earlier mapped out the lower levels to buy! This can also perhaps explain the willingness to sell at low levels and buy at high levels. The news flow is in plenty in the direction that the stock prices are taking and hence more of that news is processed by the mind rather than something contra to it. So people expect prices either to keep falling or keep rising.

Disinformation campaigns are the way that the operators manage this mental bias of traders against them. Feeding the media with more bearish sounding news at times of decline creates the mind-set of conviction for traders as they feel they are analysing ‘available’ information and arriving at valid decisions. Instead, what they are really doing is over reacting or over valuing the available information to the exclusion of the other available information (that may be to the contrary).

Availability heuristic is also one of the reasons why people are unable to fathom why a stock is falling on good news or rising on bad news. Their mental bias makes them view information selectively and exclude items that are either not played up or perhaps that are a bit less visible.

Recognizing the presence of this behavioral trait is very essential in our pathway to be a better trader and investor. We can catch our own over reaction to something in the market and we would then become enabled to watch our own actions. A self-aware trader has a greater chance to succeed in the market than someone who is simply reacting all the time.