The following excerpt and image below are from Carl Richards in a New York Times Blog post:
The recency bias is pretty simple. Because it’s easier, we’re inclined to use our recent experience as the baseline for what will happen in the future. In many situations, this bias works just fine, but when it comes to investing and money it can cause problems.
When we’re watching a bull market run along, it’s understandable that people forget about the cycles where it didn’t. As far as recent memory tells us, the market should keep going up, so we keep buying, and then it doesn’t. And unless we’ve prepared for that moment, we’re shocked and wondered how we missed the bubble.
We wanted to start this article on oil with a brief mention of recency bias for the following reason: This cognitive bias has blinded many investors from properly understanding the true fundamental supply and demand dynamics at work in crude. It is human tendency to overweight the importance of recent data relative to past information. Most of the time this is the right thing to do. But occasionally in investing, there are large paradigm shifts that vastly differ from recent experiences. In these instances, the investor would benefit from a more detailed study of historical data in order to better grasp possibilities. There is large alpha in these secular market shifts for those who stay on top of them. (Keep reading….)