The term “modernity bias” gets thrown around a lot on the trading scene, but what exactly is it?
In the most basic sense, recency bias refers to the tendency of traders to consider only the most recent set of events while ignoring older but equally important (or sometimes more important) information.
The novelty bias negatively affects the way a trader analyzes the market, as it clouds their judgment and damages their decision-making skills.
In forex, the most common manifestation of the recency bias is when a trader dwells on only his recent trading decisions and loses sight of the bigger picture.
An example of this would be a fundamental trader who puts a lot of meaning into an economic event that just happened and does not take into account the larger macroeconomic background.
Another example is that a technical trader puts too much weight on newly formed candles, which causes him to lose track of long-term trends.
It also has a psychological aspect. Let’s say there are traders.
Mike has won his last 3 trades and has an overall record of 4 wins and 6 losses. Mike’s account is up 1% since the beginning of the year.
Meanwhile, John was on a 3 trade losing streak. Junho has a record of 8 wins and 7 losses and his account balance has increased by 5% since the beginning of the year. Mike overlooks his winning streak while John falls for the pranks.
But if you look at the bigger picture, you’ll see that John is really ahead. He has more wins than losses and even his winning percentage is much greater than Mike’s.
If Mike and John choose to focus on their most recent trades, they may succumb to recency bias which could negatively affect their future trading decisions.
Mike might end up ignoring potential warning signs and jump into a trade in haste while John might get frustrated, abandon his risk management rules, and start overtrade. Obviously, neither situation is desirable.
Do you often find yourself in any of these (or similar) situations?
If you do, here are some tips to help you avoid succumbing to modernity bias:
1. Keep a detailed forex trading journal
As we discussed at Pipsology School, keeping a detailed trading journal is almost as good as having a coach watch over your shoulder and keep track of your forex trading decisions.
By monitoring your progress along with the right and wrong moves you made, you will be able to get a comprehensive view of your overall forex trading performance and avoid zoning out on your recent trades only.
2. Write down your trade plan and make sure you stick to it.
If it helps, you can come up with a checklist of all the criteria that must be met before entering a trade.
This way, you will be less likely to give in to your emotions – be it overconfidence from your winning streak or increased indecision after a trading slump – and you will be more focused in executing your trading plan.
3. Engaging in deliberate practice.
Remember, deliberate practice can remind you why you created your trade plan in the first place and why it worked.
Deliberate practice can also help you stay in sync with dominant market themes and allow you to make adjustments to your trading plan if needed.
By doing this, you will be able to take the bigger picture into account and evaluate your trading performance at the same time. Now this kills two birds with one stone!
4. Watch your emotions.
Evaluating your feelings is one of the best ways to get away from the recency bias.
If you feel that you are likely to give in to your feelings, step back and try to make a more objective assessment of your past trades.
If you think your losing streak is causing you distress, you may want to take a day off from trading or a quick vacation. Some listen to classical music for a few hours while others engage in self-dialogue or talk out loud while trading. What is important is that you discover what works best for you.