Recency bias is a cognitive bias that favors recent events over historic ones. Recency bias is the tendency to think that trends and patterns (called “momentum” in financial markets) we observe in the recent past will continue in the future.
Sadly, predicting the future in the long term according to what has recently occurred (recent trends and patterns) has been shown to be no more accurate than flipping a coin in many fields, including meteorology, economics, investments, technology assessment, demography, futurology, and organizational planning.
The Recency Fallacy is a great trouble to us, being a particularly tricky sort of behavioural bias that’s rather difficult to overcome.
It works thus: you overfocus on the most recent events you’ve experienced and neglect to worry about older information. We don’t so much integrate new information with the old as use it to overwrite our memories.
Recency bias can skew investors into not accurately evaluating economic cycles, causing them to continue to invest in a bull market even when they should grow cautious of its potential continuation (being a permabull), and refrain from buying assets in a bear market because they remain pessimistic about its prospects of recovery (being a permabear)
Recency bias increases panic and makes investors (permabear) believe that things will continue to go wrong because right now they are going badly, forgetting that in most cases the world stock market is more positive than negative, despite it has witnessed very strong shocks, including world wars, epidemics, inflation, political crisis, etc.
In order to minimize the impact of recency bias on your decision making, you should learn to
- filtering out the noise produced by the most recent informations
- focus on he big picture looking at the history
- remember the “regressione to the mean”…..”everything that goes up, sooner or later goes down”
During a market crash, it can be difficult to remember that market declines are fairly regular occurrences, if you do not observe the full historical picture and remember of the powerful regression to the mean.
Below you can see a nearly 150 years picture od stock market performance. You can clearly see that crashes would happen in average about every nine years.