What’s a Recency Bias?
The recency effect describes our tendency to better remember information that was most recently told to us. It is believed that the recency effect occurs because those items are stored in our short-term memory, which is only able to hold a small amount of information at a time. It stores the information that was most recently told to us allowing us to access it during recall quickly.
One real-life example ( not related to investing ) that I remember was - When famous Indian actress Sridevi died, there was a poll conducted on social media asking who was the all-time great actress. Due to the recency bias, most came up with Sridevi’s name.
On the same note, if I carry a poll of the worst performing Indian batsman now - the most probable answer will be K L Rahul as he has a poor track record in the recent past. And if you had surveyed for the best batsman in the world after the recent nail-biting India-Pakistan T-20 match at Melbourne, the obvious answer should have been Virat Kohli.
When it comes to investing, recency bias often manifests in terms of direction or momentum. It convinces us that a rising market or individual stock will continue to appreciate, or that a declining market or stock is likely to keep falling. This bias often leads us to make emotionally charged choices—decisions that could erode our earning potential by tempting us to hold a stock for too long or pull out too soon.
A few more examples that I can think of are
Stocks in continuous upper / lower circuits - Retail investors in the greed of making QUICK money, fall prey to penny stocks. These are typically manipulated by operators. When small investors see these stocks going up daily in upper circuits, they fall prey to RECENCY BIAS and hence the FOMO and then ACTION BIAS - they end up buying them. And the same thing repeats on the way down and retailers lose their hard-earned money. The same can be said for the BUZZING stocks in Social Media. They induce the Recency Bias and then FOMO & Action Bias.
Recent Cryptomania - During the COVID times, due to liquidity, there was a bubble in all the Cryptocurrencies and when common people saw all these cryptos just going up daily, they assume that investing in them was the sure shot way to getting RICH QUICKLY. So many people ended up buying them due to FOMO and then lost BIG when liquidity was sucked out of the system.
COVID Gloom & Doom - During the peak of covid pandemic, people were so scared that if you should have asked about the possible deaths due to covid, the majority of them should have come up with some figures even higher than combined World War I & II deaths.
Mutual Fund Performance - This is again a classical example of recency bias. When choosing the MF to invest in, people tend to look at the RECENT performance say last quarter / last year. So if the fund has not performed well recently, we think it’s bad and we avoid it. And the other way, if the recent performance is good, due to the recency bias we tend to invest in it.
We, retailers, check our portfolio performance very frequently even every few minutes. This can be so detrimental. Because, when we see our stocks in red every few minutes, the RECENCY BIAS can kick in which may lead to ACTION BIAS. So we may either end up selling that stock or may average it down to avoid the LOSS AVERSION.
So the point is - all these behavioral biases are interlinked.
Ok. So what’s the solution ?!
Be very selective in what you read on SM. Pick only useful groups on WhatsApp & Telegram. Follow a few selected Twitter Handles. Read selected websites and research reports only. The less the SM Noise, the less Recency Bias will be.
2 - Sleep Over that idea.
Whenever you come across a new stock idea, take some time, apply some checklists, and then only buy it. This will avoid Recency Bias, the FOMO & the subsequent Action Bias.
3 - Maintain your own Investment Diary.
The more I am thinking and write about all these Biases, the more I am realizing the importance of writing an investment journal. Be it physical or digital. It will force you to write your Investing Thesis & Anti-Thesis about the stock. Also, write in which circumstances will you sell the stock even before buying it. This will help immensely by avoiding many behavioural biases.
That’s all on the Recency Bias. Hope you liked it.