Price matters

• Posted by Ivanhoff
• on May 29th, 2009

People, suffering from cold, were asked to buy medicine with different price range. When surveyed, those who tried the more expensive medicine, reported that they recovered faster. The reason wasn’t in the price. It was their expectations. When you pay more, you expect that you’re getting the best possible decision to a problem. Your expectations become a self-fulfilling prophecy. This is why placebos work so often and this is why the effectiveness of new medicines is always compared to the effectiveness of placebos.

Another experiment was performed. People, suffering from headache, were asked to try 2 pills. One was sold at the market for 1 cents, the other for 99 cents a pill. The surveyed didn’t know which pill is which and in the end of the day the results from the two pills were very close. A week later, the same experiment was conducted. This time all participants were told that one of the pills is state of the art, miracle of the medicine and very expensive. The other was an ordinary aspirin sold for a 1 cent per pill. The difference in the results was stunning. The people who used the expensive pills got better, faster.

Relying on price is the most often taken shortcut in our world. It is natural for a human being not to be proficient in everything. After all, the available information doubles every month. There is no physical possibility to keep up with everything and be an expert in everything. This is why, we often choose to rely on price. Expensive is often regarded as high quality; cheap is often thought to be inferior. That doesn’t mean that we are always right. On the contrary. Such simple minded approach guarantees that we will be wrong in many cases. But in a world that gets more complicated by the second, relying on price as a measure of quality is a safe bet. Safer than anything else. 

The same approach could be applied to equity selection. It is true that high priced stocks don’t double as often as let say $1 prices stock, but they are also more liquid and less volatile. In my position sizing approach, I always take into account the individual stock’s volatility and its price.  Higher priced stocks provide the opportunity to use tighter stop in percentage terms, which means much better trading opportunities in term of risk to reward.

I will be glad to hear what is your take on the subject.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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