Updated: Jan 24
Hey friend, ever caught yourself making a trade based on how you're feeling instead of what the facts say?
Yeah, we've all been there.
But the good news is, by understanding and recognizing these biases, you can prevent them so you can make better decisions.
Here are five common biases traders fall into and how to avoid them:
This happens when we look for and interpret information to confirm our pre-existing beliefs. In trading, it can manifest in ignoring or dismissing information that contradicts our beliefs, overvaluing information that confirms them, or actively seeking out information that confirms them.
To avoid this, you need to learn to be open to the possibility that your beliefs may be wrong.
The best thing you can do for this is to make sure you have an objective trading plan with rules you can follow easily.
If you want to learn to trade in a rule-based way with the rules laid out check my Rule-Based Trading Programme. Where I show you my personal strategies and also how to create your own to adapt your personality.
This happens when we put too much emphasis on recent events when making decisions instead of considering a complete historical record.
In trading, it can manifest in overconfidence in recent trades, and over-risking or overtrading.
It can also come in the form of fearful trading where because you lost the last few trades you ignore the next trade thinking it will probably be a loser but in reality, the outcome of the next trade is completely random.
To avoid this, you need to think probabilistically. The best way is to make sure you have tested your strategy and use your tested data as confidence.
In your tested data you will see a random distribution of trades some may be winning streaks and some losing streaks as well but when you look at the data in a larger sample size you will see the results come out positive (Of course if you have a positive edge)
To learn more on how to test and confirm you have an edge you can learn more here!
This happens when individuals in a group adopt the same beliefs, attitudes, or behaviors as the group instead of thinking independently.
In trading, it can manifest in following the crowd, feeling pressure to join in on a particular asset or strategy, or a lack of original thinking.
I see this happen all the time by traders most recently with bitcoin where everyone is just jumping in without any system and just following the crowds.
To be a great trader you need to be an independent thinker and have complete trust in yourself and your plan.
So to avoid falling for this bias you need your own trading plan and you need trust and conviction in it as well as yourself and this first comes from doing the work behind the scenes.
Another good start would be to close any social media, news, or negative influences that have the potential to sway you the other way.
Out of sight is out of mind!
This happens when we rely too heavily on the first piece of information we receive when making decisions.
In trading, it can manifest in basing our trading strategy on the first piece of information we received, or not adjusting our trading strategy as market conditions change.
To avoid this, again you need to have a clear process and plan in place that you follow without question.
The Gambler's Fallacy:
Also known as the Monte Carlo Fallacy or the Fallacy of the Maturity of Chances, is a bias that traders can fall into.
It refers to the belief that if a certain event happens repeatedly in the short term, it is less likely to happen in the long term.
For example, if a coin is flipped and lands heads-up repeatedly, some traders may believe that the next flip is more likely to land tails-up because the coin is "due" for a tails outcome.
However, in reality, the probability of the coin landing heads or tails is still 50/50 on each flip and it is not affected by the previous flips.
In trading, this is a common thing I see. Let's say you have 7 losers in a row. Most traders would believe that because they have had so many losers in a row they must be due a win. And often with this bias in mind, they will disregard risk and load up trying to make back the past losses.
When in reality the chances are still 50/50.
You need to think in probabilities, each trade is random but as long as you follow your plan and manage risk then you have nothing to worry about the positive expectancy will eventually come to fruition despite the short term.
So stick to the plan and manage risk accordingly...
So now you are aware of some of the most common trading biases how do you know which ones are really affecting your trading?
The best possible thing you can do right now is to implement a trading journal and keep detailed records of when you are experiencing biases like these so you can then create corrective actions to prevent them from sneaking into your trading.
That's why I created my Emotional Trade Tracker which simplifies the whole process of tracking Biases, Sabotaging emotions, and triggers, and creating a systematic process you can implement to create corrective actions to prevent further pain down the line.
You can get it here: Emotional Trade Tracker
Remember, recognizing and understanding these biases is the first step to overcoming them.
By being aware of these biases, we can make more informed and rational trading decisions.
Hope you enjoyed today's blog!
If you have any questions just comment below!
Have an incredible day my friend!
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