The availability heuristic is a mental shortcut that occurs when people make judgments about the probability of events by how easy it is to think of examples.
The availability heuristic operates on the notion that if something can be recalled, it must be important.
The availability of consequences associated with an action is positively related to perceptions of the magnitude of the consequences of that action.
In other words, the easier it is to recall the consequences of something, the greater we perceive these consequences to be.
According to the availability bias, people tend to heavily weight their decisions toward more recent information, making any new opinion biased toward that latest news.
One consequence of having emotion in the stock market is the overreaction toward new information. According to market efficiency, new information should more or less be reflected instantly in a security’s price. For example, good news should raise a business’ share price accordingly, and that gain in share price should not decline if no new information has been released since.
Traditional economics say that people process information in an objective and rational manner. The reality, however, is that most of us process information in an emotional and irrational manner.
This bias occurs when our mind gives more importance to the evidence that easily comes to our mind.
One reason could be the media and news information that flows heavily always and we think that events are more important than they really could be.
Recent events that our mind had registered are further magnified by the news and information.
When the events are vivid and clear and more memorable, it influences the way we think and react.
But, few times this may be useful to make quick and proper decisions. For example, if you had suffered a food poisoning after eating in a restaurant, you will remember that and will make proper decisions and even advice your friends accordingly.
Availability Bias in our daily lives
- If you have noticed a car accident recently, you will be driving more cautiously for next few weeks or months, after some time passes, however, your driving would be back to normal
- Availability bias causes investors to over-react to market conditions whether they are positive or negative.
- People buy lottery tickets because the recent wins are heavily advertised. So people think they also have a chance to win, than they really are
- A doctor who has recently came across a new type of virus in patients for the past few days, would more likely look for the same symptoms in the next patient.
- A smoker may continue to smoke without much of fear, because, he may have recently seen a news clipping where a smoker is living past 100 years.
- Investors may buy mutual funds and ULIPs and other Insurance products that are heavily advertised, rather than doing their own analysis
- Investors may decide not to invest in European companies as they are going through debt crisis in Greece and few other countries.
Overcoming Availability Bias
- Do your own analysis and research before making any investment decisions.
- Slow down your listening to media and news information. Do not give more importance to them.
- Ask yourself if you are taking decisions emotionally.
My experience with Availability Bias
- During the 2007 bull market phase, I was attracted a lot by news and information flow about the Infrastructure sector and related IPOs and invested in them. The IPOs fell from their listing price and lost value over time. I had to sell them at a loss later and invested in better opportunities
- Similarly, during 2007 there were a lot of mutual funds NFOs and influenced by my friends to buy a few of them. Fortunately, few performed better and I sold for a profit, and I had to sell the remaining at a loss.