Trading biases can severely impact our ability to read the markets objectively and make good trading decisions.
The first step to overcoming these biases is to become fully aware of them.
Here are five of the most common biases in Forex trading. What biases are you committing?
1. Recency bias
Do you often find yourself getting caught up in your recent trading decisions and losing focus on the big picture? Then you, my friend, may be guilty of retrospection bias!
Recent bias has a way of clouding judgment and impairing sound decision-making because it involves placing undue importance on more recent events.
Note that this does not only apply to trading decisions, such as losing confidence after two or three losses. It can also affect the way you analyze the markets.
If you focus too much on a single economic event and fail to take into account the larger fundamental background, or if you limit your analysis to the most recent candles and lose track of long-term trends, you are also guilty of recency bias.
To deal with this problem, take a step back and evaluate the longer-term situation of your Forex trading or investment portfolio. Always keep the big picture in mind, and don’t let your recent success or failure influence your trade execution.
2. Confirmation bias
As humans, we tend to listen more to analyses that support our views and opinions and undermine those that oppose them. After all, it’s in our nature to want to be right. Right?!
The problem here is that this makes our trading decisions more subjective. It is easy to ignore bearish signals from the market if you have read very bullish analysis and have already decided to enter long-term trades!
Fixing this problem requires being flexible and open to other people’s opinions. A different group of people may see things that you don’t. The best way to get a balanced view and see both sides of a story is to consult with different analysts.
3. Herd bias
Have you ever backed out of a trade when you discovered that a group of other traders were taking the opposite position in the Forex market? If your answer is yes, then you are a victim of herd bias.
Just as sheep try to move with their flock, traders also tend to follow the majority and often feel uncomfortable when they stray from the crowd. It’s human nature and we can’t control it, right?
mistake!
As a trader, you shouldn’t be afraid to take a position that goes against the trend. Just make sure you do your homework, conduct proper fundamental and technical analysis, and plan your trades well.
If you have reason to believe that the markets are about to turn, you don’t have to simply go with the flow and jump into the ongoing trend just because your mother and your mother’s mother said so.
If you need additional confirmation to complete a trade that seems contrary to popular opinion, our lesson on measuring market sentiment may be able to help.
4. Attribution bias
Psychologists define attribution bias as cognitive errors in the way people determine who or what is responsible for an event or outcome. What do you say?!
In trading, attribution bias occurs when you attribute winning trades to your own crazy skills and blame losing trades on external factors, such as the unpredictability of the markets or a very slow internet connection.
My all-time favorite business psychologist, Dr. Brett Steinberger, says that having this kind of bias can distort our decision-making process.
How can you control your trades if you constantly believe that everything that can go wrong is beyond your control? What’s more, if you don’t give credit where credit is due, how are you supposed to identify bad trading habits that need to be corrected?
This is where having a detailed business journal comes in. List what you did right, what you did wrong, what you expected and didn’t expect, and what you could have done better.
According to Dr. Steinberger, this will help you gain control over your strengths and weaknesses, which may make you more aware of your trading processes.
5. Bias towards addiction
As traders, we have a very clear memory of our “Hall of Fame trades,” just as a fighter clearly remembers his glory days.
Remember, it’s not enough to just hold onto memories of those big wins; the numbers have to back them up. Ultimately, you need to make trades that have a high probability of success for you.
If you are guilty of any of these biases in forex trading, it is best to take steps to remedy it.
There are plenty of tools and resources available, so you’ll have no excuse not to break those bad habits!