Biases are present in various aspects of our daily lives, and you guessed it—they undoubtedly influence traders during trading. No wonder there is an entire field of study, more precisely, called behavioral finance which predicts actual trading behavior based on these factors.
We’re not saying that having trading biases is a bad thing, however, it may lead to traders being short-sighted and making unfavorable trading decisions. Read on as we elaborate more on what these biases may look like in your trading journey and how to overcome the limitations caused.
Like everything else, there can be too much of a good thing. Overconfidence can extend to two main areas in trading: a) the quality of the information you possess and b) your ability to effectively utilize the information for maximum profit. Excess confidence frequently impairs your trading judgments, resulting in greater-than-necessary losses.
In order to not get caught up in too much self-assurance, one should understand that without objective research, your decisions based on urge and intuition will not be able to get you far. Keep in mind that one winning streak doesn’t guarantee future results.
Unlike overconfidence bias, loss aversion bias is more common among not-so-confident traders, as it tends to present itself in the middle of a losing streak, which is understandable given the circumstances. Loss aversion bias basically means that the fear of losing is stronger than the pleasure of gaining. A trader with this bias is likely to prematurely close profitable trades instead of allowing them to continue and maximize potential gain.
Creating a thorough trading plan that entails how much you’re willing to lose as well as how much you want to gain should be the first step in your trading journey. That’s not all, because the second step— sticking with your trading plan, is equally just as important to avoid taking unnecessary losses.
If you find yourself making trading decisions based on what feels familiar from past experiences, you could be operating on an anchoring bias. For example, traders hold on to losing positions longer than they should because they have an anchoring belief that the situation will turn out exactly how it did before. This doesn’t imply that market predictions based on price patterns should be thrown out the window. However, this bias hinders new information, making it difficult to acknowledge the possibility that your current information may be irrelevant.
It is crucial to conduct comprehensive research and analysis of the market so that you’re able to identify your own anchor that may be weighing your trading strategies down.
Confirmation bias stands out as one of the most prevalent biases among traders. It refers to the inclination to actively seek and give more significance to information that aligns with pre-existing predictions or beliefs. In other words, traders exhibiting confirmation bias tend to focus solely on data that reinforces their decisions while disregarding news that contradicts their convictions, even if such information could be valuable.
Carrying out your analysis and believing the data to be correct, even if clashing with your preconceptions, can be beneficial in preventing this bias. By playing the devil’s advocate with your gut feelings, it compels you to evaluate each trade based on its merits.
If you find yourself relating to any of these biases, this is your sign to acknowledge and reflect on their potential impact on your trading journey. The best approach is to establish a set of trading rules which serves as a guiding framework for trading decisions. Of course, trading biases can be challenging to eliminate altogether, but you can minimize their effect to maximize your trading potential.