Trading is an attractive prospect to many as it can be a lucrative “side hustle” that improves your financial health and can even be an interesting and enjoyable way of earning a living. One of the biggest obstacles that traders face is the development of bad habits that can sabotage their success. The article discusses trading psychology and the importance of avoiding bad habits that stem from psychological and cognitive biases. While there are many resources that teach good trading practices, it is crucial to recognize and address non-learned behaviours that can negatively impact trading performance.
1. Comfort Zones
Fear of the unknown often keeps traders from venturing outside their comfort zone, leading to only trading familiar stocks and industries. This approach can result in holding onto losing stocks for too long and missing out on more profitable opportunities. However, with proper research, leaving one’s comfort zone can be beneficial. The key takeaway is that traders need to overcome the fear of the unknown to explore new opportunities and enhance profitability.
Overconfidence can lead to reckless trading decisions, even if the underlying strategy is poor. Traders can become too confident after a single big payout, leading to increasingly risky trades and greater potential for losses. The key takeaway is that traders should be aware of the impact of overconfidence and avoid making impulsive trading decisions based on a single win.
Resulting is the process where traders attribute their profits solely to their own ability but losses to external factors. This bias can be harmful as it fails to highlight issues with their own behaviour and trading strategy. It is important to be neutral when evaluating trades, as occasionally, poorly performing trades can be attributed to external factors. It is a good idea to evaluate decision-making rather than outcome, as the latter can be subject to randomness. The key takeaway is that traders should recognize and address attribution bias to make more objective evaluations of their trading decisions.
4. Not Sticking to Your Guns
“Not sticking to your guns” is the issue of indecisiveness in trading, where traders abandon their current strategy for a potentially more profitable one without proper research. This can be harmful as it may lead to ineffective trading and losses. It is best to stick to a sector or instrument that traders are familiar with and have thoroughly researched. Traders should avoid jumping into new strategies without proper research and should stick to what they know to make informed and effective trading decisions.
5. Sticking to Your Guns
Slightly counterintuitively, we next have the issue of sticking to an ineffective strategy for too long. Traders may have done extensive research and formulated a strategy, but for some reason or another, it is not working. Instead of reflecting and adapting, they continue with the strategy, thinking they have done everything right. However, traders should be evaluative and make necessary changes, even if they’re just minor oversights that need adjusting. Effective research is essential, but traders should always be willing to adjust their strategies if they are not working.
Traders can fall into the trap of anchoring, where they focus on certain sources of information while ignoring others. This focus can be as the result of any bias (including political and personal). This can affect traders’ decisions on their strategies and can lead to missed opportunities. It is important to evaluate the veracity of all information sources and the information that source is conveying, regardless of personal opinions.
7. Confirmation Bias
In a similar vein, another issue that traders face is confirmation bias, which is the tendency to stick to information that confirms their own beliefs. This is slightly different from anchoring, which is more systematic, as confirmation bias is on a more individual basis. For instance, let’s say you believe there is an asset bubble forming in a certain market, and you look for information surrounding this hypothesis. If 9 out of 10 news sources say otherwise but you decide to believe the 10th, this would be an example of confirmation bias. To avoid this bias, it is important to embrace information that points to the contrary and evaluate it separately.
8. Survivor Bias
The last concept to consider is the idea of survivorship bias. This phenomenon can be illustrated by an example from WWII, where planes that returned from battle showed bullet holes all over the aircraft except around the engines. As a result, the air force believed they should reinforce the areas with bullet holes and not the engines, but this was not an accurate decision as aeroplanes hit in the engines did not return home. This concept can also be applied to markets, where traders look for indicators in markets before they blow up, but this approach only focuses on markets that have performed particularly well and not all stocks. Consequently, traders may overestimate the profitability of a market based on the indicator, which is not representative of all stocks.
Dealing with Biases
The article discussed how our psychology can affect our trading on a subconscious level, and being aware of this is the first step to making positive changes in our trading practices. One suggestion for overcoming these bad habits is to remove biased inputs and focus on simple strategies that are based on objective decision-making. Admittedly, this is much easier said than done, but even if you are not perfect, you are still putting yourself in a strong position moving forward. Additionally, it is important to have a good understanding of how the markets operate and move in real time in order to reduce fear and make informed decisions. To further improve our trading, we should identify and address our bad habits, such as resulting in overconfidence. A good example of one such technique is to keep a trading journal so you can critically analyse your past decisions. Finally, we should be willing to take breaks from trading when needed and engage in activities that promote relaxation. All of these ideas require discipline and dedication, but the payoff of becoming a consistently profitable trader is worth it.
Trading Psychology Takeaways
We have discussed the impact of psychological biases on traders and how you can avoid bad habits that can sabotage their success. The article outlines 8 common biases that can affect all traders. The key takeaway is the need for awareness of these biases and errors to recognize them when they arise, and other strategies for dealing with them should also be explored. Removing biased inputs and focusing on simple strategies based on objective decision-making is an effective way to overcome biases, but not being too stuck in your own ways is also key. Additionally, you should always be willing to take breaks from trading when needed and engage in activities to reduce stress and improve focus and adaptability.