Cognitive Biases Part 5: Recency Bias

"Past performance does not necessarily reflect future returns"

We hear this disclaiminer in most advertising for financial service products. Most people though have a hard time letting this sink in when they are making investment decisions.

A great deal of our decision making is driven by events and images of the moment and the recent past. We are heavily influenced by the Now.  The narrative goes that if stock prices are rising now, they will continue to rise well into the future. If real estate prices are rising 10 percent this year then they will be rising by 10 percent again next year.  Heck most Bay Street and Wall Street equity research reports will take the most recent earnings and project them well into the future, sometimes almost 10 years. Conversely when the stock market imploded in 2008, many investors went into a shell for many years, fearing that the carnage was set to continue. This behavior to assume current prices or market conditions will exist in the long term is known as Recency Bias.

This dynamic is triggered by the content and images we consume.  Have a look at these headlines:

 

….and these magazine covers in 2005…

 

….we know how that story panned out.

Source: Elliott Wave Financial Forecast

Source: Elliott Wave Financial Forecast


Flash forward to today, the big meme running these days in my neighbourhood...

Magazine covers and newspaper front pages do a good job of capturing hot or not moments in the business/economic arena. Watching TV gives us also great queues on the Now. When the evening news leads with a story on the stock market or a high profile business event. Unfortunately they also represent a Jump the Shark or peak moment of that business dynamic. After the easy money has been made, these snapshot events tend to go the other way shortly after.  Unfortunately, the timing of when these events go the other way is not exact as Robert Shiller has shown us.

If you can stay aware of these snapshot moments of the Now, you can identify potential peak points of a business idea or stock price and take advantage of these moments to take the other side of the trade and profit handsomely.