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Primacy Effect On Trading And Investing Decisions

Most traders and investors who are active in social media probably got involved with the markers during the 90s bull market or after that with the S&P 500 index below 1500. The Primacy Effect explains why many get excited when ES futures are down 20 points overnight.  Escaping this cognitive bias is simple in principle.

The Primacy Effect is a cognitive bias due to the tendency to remember older information better than more recent.

Below is a chart of ES futures since 1998. The indicator at the bottom is the percentage of a 20 point change based on the closing price.

If you are looking these days at -20 points changes overnight in ES futures and you are getting excited you are probably still living mentally in the period marked by the red box in the above chart.

For example, on January 3, 2006, a 20 point drop translated to about  -1.6% change in the contract. Nowadays, that is about 0.6% change.

As prices rise, constant point change impact diminishes but the Primacy Effect is often strong and many think the point change is important.

We should not underestimate the adverse effect of this cognitive bias on trader and investor actions and also possible impact on profitability.

Solution: Do not pay attention to price changes but only to returns. This is what modern finance does anyway. Looking at price changes is useful for some purposes but not when Primacy Effect is dominating.

Charting and backtesting program: Amibroker

Data provider: Norgate Data

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