Tipping Point: What is recency bias?

What is recency bias?

In behavioural economics, recency bias refers to the tendency to allow recent events to affect our judgement excessively. People extrapolate recent events and expect similar trends to continue in the future as well. They don't give enough weight to the fact that a lot of phenomena (including the markets and economy) tend to be cyclical.

How does this affect you as an investor?

It is especially important to be aware of recency bias on a day when the Sensex has crossed 30,000. There is a lot of optimism all around. Many new investors, who have seen friends and neighbours make money in the markets, may jump in, expecting the markets to continue upward. Existing investors may not book profits and rebalance. Investors may not pay sufficient attention to the fact that valuations are already quite stretched, especially on the mid- and small-cap side. If there are adverse developments — such as negative geopolitical events abroad or a delay in earnings recovery in India — the markets could correct from current levels.