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• Recency bias: The tendency to weigh recent data or
experience more than earlier data or experience
• Anchoring: The tendency to rely too heavily, or anchor, on
readily available information
• Bandwagon effect: The tendency to believe things because
many other people believe them
• Belief in the law of small numbers: The tendency to draw
unjustified conclusions from too little information
Although this list is not comprehensive, it includes some of the
most powerful misperceptions that affect trading and prices. Let’s
look at each cognitive bias in greater detail.
People who are affected by loss aversion have an absolute preference
for avoiding losses rather than acquiring gains. For most people, los-
ing $100 is not the same as not winning $100. However, from a
rational point of view the two things are the same: They both rep-
resent a net negative change of $100. Research has suggested that
losses can have as much as twice the psychological power of gains. 
In terms of trading, loss aversion affects one’s ability to follow
mechanical trading systems because the losses incurred in following
a system are felt more strongly than are the potential winnings from
using that system. People feel the pain of losing much more strongly
when they follow rules than they do when they incur the same losses
from a missed opportunity or by ignoring the rules of the system. Thus,
a $10,000 loss is felt as strongly as a $20,000 missed opportunity.
In business, sunk costs are costs that already have been incurred
and cannot be recovered. For example, an investment that already
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has been spent on research for a new technology is a sunk cost. The
sunk cost effect is the tendency for people to consider the amount
of money that already has been spent—the sunk costs—when mak-
ing decisions.
Say the ACME Company has spent $100 million developing a