Breakout Trading and Anchoring Bias

Just today, a good friend of mine was commenting on how a lot of stocks had moved strongly higher in recent days and maybe it was not advisable to buy at current prices but instead wait for a correction before entry.

The rationale offered by my friend fits the “Anchoring Bias” perfectly. We anchor ourselves to prices that we have seen in the past and instead of analysing whether a trade is still worth at the current juncture, we tend to generally hope that we shall buy it when it comes down to a price where we supposedly missed it.

A lot of stocks come to one’s attention only after they have made some thing spectacular to merit a mention. So, the day, a stock moves above its 52 Week high is one time where in we see the stock suddenly gathering the limelight. So, instead of buying that breakout, we repent the fact that we missed the stock when it was cheaper earlier.

Let me give you a example (thanks to my 20/20 Hindsight Bias). This stock was trading between 30 and 45 for long and suddenly broke off and multiplied 5x times.

As can be seen on the chart above (Click on it to expand to full size), the stock saw a parabolic rise once it crossed 80 bucks. The question I would like to ask is, what would been your confidence in buying this stock at this juncture (for the moment lets assume this is a company that seems to be turning around the corner as far as fundamentals are concerned).

Chart of the same stock as it traded in a large band over the next few months. If you had bought, would you have held it on? If you had not bought earlier, would you be more inclined now?

Same question as above. Even more time spent while stock seems to have taken a break and actually declined. Would you have given up?

A Break-out and a failure of the same. What would you be thinking now?

Another breakout. Should we Buy now or wait for a re-test of the breakout?

The stock chart as it looks now 🙂

The thing with break-out trading is that after every failure, our next entry is higher than our earlier entry and unless you take the system as it is as opposed to using our grey cells, we shall miss out on the biggies while we get caught with endless breakout failures and finally decide that maybe breakouts aren’t the best way to trade after all.