Having trading biases isn’t necessarily a bad thing, but there are some that can impair our ability to read the markets and make good trading decisions.
The first step to overcoming these biases is to become fully aware of them. Here are four common ones you should be mindful of.
1. Anchoring bias
An anchoring bias refers to the tendency of a trader to rely on what is familiar, such as future outcomes being EXACTLY the same as past results.Of course a lot of market predictions are based on price patterns, but having an anchoring bias means that one might be prone to brushing off new information or changes in market environment.
As a result, a trader with an anchoring bias could be stuck in a “mental comfort zone” and rely purely on old and possibly irrelevant data.
If you find yourself holding on to losing positions for too long and insisting that price action will turn out a certain way JUST LIKE IT DID BEFORE, then you might be giving in to anchoring bias!
2. Confirmation bias
Confirmation bias is probably the most common one among traders. This refers to looking for information that will support a prediction or decision as a way of justifying it.By doing this, you wind up ignoring important market information that challenge your idea, possibly even dismissing warning signs that your decision might be wrong.
This could create an infinite loop of misinformation, likely resulting in wasted time Googling articles simply to strengthen one’s conviction. Even worse, this could result in losing money because of a poorly-constructed trade idea.
3. Overconfidence bias
Ever found yourself on a winning streak and feeling absolutely sure that you’ve mastered the markets?
There’s nothing wrong with building confidence in your trading skills and strategies, but there’s always the danger that too much self-assurance could overshadow your trading decisions and proper risk management.
Being overconfident might convince you that you’ve learned all that you possibly can or that you don’t need to put in more time in analyzing price action and developing your skills.
4. Loss aversion bias
Now this particular bias tends to affect the not-so-confident trader. After all, the fear of losing typically manifests during a large drawdown or in the middle of a losing streak.While minimizing losses matters in preserving your capital, risking too little could wind up doing more harm than good. As my buddy Pipcrawler likes to say “You gotta risk it to get the biscuit!”
A trader with loss aversion bias is also likely to cut profits instead of pressing on and letting a winning trade run. He might also be more willing to keep a losing trade open for much longer in hopes that it will turn at some point.
Now that you’re aware of these common trading biases, hopefully you’ll be able to catch yourself before making the usual mistakes associated with these.