What are some of the most common biases we face as traders? There are an infinite number of biases we face daily, the ones that are listed below are the most common ones faced by traders. They are not ranked in any specific order:
- Optimism/pessimism bias
Your past and recent results have a big impact on your trading. If you have done well then, you will be optimistic. If you have performed poorly, you will feel pessimistic. This rollercoaster of emotions influences your trading. Being pessimistic can even make you stop trading or tinkering with your system.
Understand that you will never get every trade right, understand where you went wrong and learn from it.
- Overconfidence bias
Most of us overate our knowledge and capabilities. We believe we know what is going on in the markets but realistically we are winging it, we rush into trading with the hope of making quick, easy money, without knowing the basics.
Be humble, always be willing to learn and broaden your horizon, thinking that you are smarter than the market is a mistake and could cost you. Stick to your strategy.
- Self-serving bias
The habit of taking credit when something positive happens but putting the blame on someone else when something negative happens. We judge the quality of our decisions based on the outcome which is wrong. Good decisions often lead to wrong outcomes and bad decisions often lead to good outcomes.
Always take responsibility regardless of the outcome. No one is forcing you to trade and no one is making you push the buy/sell button, this is all your responsibility.
- Confirmation bias
We stick to information that confirms our beliefs. We should rather always question our beliefs. You should welcome conflicting evidence and thoughts as this will help your learning process improve.
- Gambler’s fallacy bias
This is the belief that if a particular event occurs more frequently than normal during the past, it is less likely to happen in the future. What your brain is doing is essentially using statistics in an inverse manner to support the belief that you will eventually stop losing money if you keep doing the same thing. The market is not a casino, sure, statistically that thing will eventually give you the outcome you want but if that is how you want to trade then you have to conduct a full-scale backtest and use real math to work out the probability over years of data.
Now that we have seem some of the biases we may experience, how exactly do we overcome them? We will never really be able to overcome our biases but rather we need to be aware of them and manage them. We need to make our trading as rational as possible. Understand where your biases are coming from, learn from them and adapt to better your trading.
- Ryan Mowatt, The Performance Coach