The Hindu Business Line : <I>Exposure effect </I>

My friend, who is a fairly successful trader, suffers from a certain bias. He will not buy a stock on which he has suffered a loss of more than 10 per cent in his previous trade. To give an example, he refused to buy VSNL recently because his previous exposure at Rs 395 ended in a huge loss. Some of us suffer from a bias that is complementary to my friend's behaviour. It is called "exposure effect". What is this effect? Take VSNL. Suppose you had bought this stock at Rs 350 some time in early January . You would have taken profits when the stock touched Rs 400 in mid-February. Now, suppose your financial adviser had told you to buy the stock again at Rs 365 in late February, how would you have responded?

If you are a typical trader/investor, you may have pounced on the idea of buying VSNL again. You and I are comfortable with stocks that we have already traded with. The reason? We carry this belief that just because we have made profits in a particular stock in the previous trade, we will be able to do so again. Psychologists call this behaviour as the "exposure effect". That is, we express undue liking for things just because we are familiar with them. In fact, advertisers use this behaviour to their advantage, which is why this behaviour is also called "familiarity breeds liking" effect. The point is that such cognitive bias could hamper you from trading profitably. After all, past is no indicator for the future, especially so in the stock market. It is, therefore, not rational for you to expect to successfully trade VSNL or any other stock just because you did so in the past.

(The author is Head, Research, Navia Markets)

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