Having trading biases is not 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 things to be aware of.
1. Establishing bias
Established bias refers to a trader’s tendency to rely on the familiar, such as that future results will be exactly the same as past results.
Of course, a lot of market predictions are based on price patterns, but having an entrenched bias means that one may be prone to ignore new information or changes in the market environment.
As a result, a trader with an anchoring bias could be stuck in his “mental comfort zone” and completely dependent on outdated and possibly irrelevant data.
If you find yourself holding onto losing positions for far too long and insisting that the price action will end a certain way just as it did before, you may have succumbed to the entrenchment bias!
2. Confirmation bias
Confirmation bias is perhaps the most common among traders. This refers to looking for information that supports a prediction or decision as a way to justify it.
By doing this, you end up ignoring important market information that challenges your idea, and perhaps even ignoring warning signs that your decision may be wrong.
This can create an endless loop of misinformation, likely leading to wasting time searching articles on Google just to bolster one’s conviction.
Even worse, this could lead to losing money due to a poorly constructed trade idea.
3. The overconfidence bias
Have you found yourself on a winning streak and feel like you have mastered the markets?
There is nothing wrong with building confidence in your trading skills and strategies, but there is always a risk that excessive self-confidence may overwhelm your trading decisions and proper risk management.
Overconfidence may convince you that you have learned all you can or that you do not need to spend more time analyzing price action and developing your skills.
4. Loss aversion bias
Now this particular bias tends to affect the insecure trader. After all, the fear of losing usually manifests itself during a major downturn or in the middle of a losing streak.
While minimizing losses is important in preserving your capital, risking too little can do more harm than good.
A trader with a tendency to lose aversion is also more likely to cut their profits rather than squeeze out and let a winning trade run. He may also be more willing to hold a losing trade open longer in the hope that you will turn around at some point.
Now that you are aware of these common trading biases, we hope you can spot yourself before making the usual mistakes associated with them.