Be Aware of Those Cognitive Biases

Dec 6, 2022

Hello everyone

Cognitive biases are a common phenomenon in the world of trading, where the pressures and potential rewards can lead even the most rational individuals to make irrational decisions.

These biases, which are essentially mental shortcuts or errors in thinking, can have a significant impact on a trader's decision-making process and ultimately their performance.

One of the most common cognitive biases in trading is the confirmation bias, which is the tendency to seek out information that confirms our existing beliefs and to overlook or dismiss information that contradicts them.

For example, a trader who believes that a particular stock is undervalued may only focus on news and data that supports this belief, ignoring any information that suggests otherwise.

This can lead to a distorted view of the market and ultimately to poor decision-making.

Another common bias is the overconfidence bias, which is the tendency to overestimate our knowledge and abilities.

This can lead traders to take on more risk than they can handle, as they may believe that they have a better understanding of the market than they actually do.
This can be especially dangerous when combined with the confirmation bias, as overconfident traders may be more likely to ignore warning signs or contradictory information.

The sunk cost bias is another common cognitive bias that can affect traders.
This is the tendency to continue to invest in a losing position because we have already invested a lot of time, money, or effort into it.
For example, a trader may hold onto a losing stock for too long because they don't want to admit that they made a mistake or because they believe that the stock will eventually bounce back.
However, this can lead to even greater losses, as the trader may be better off cutting their losses and moving on to more promising opportunities.

Cognitive biases can have a major impact on a trader's performance, so it's important to be aware of them and to take steps to mitigate their effects.
One way to do this is to develop a trading plan that outlines specific rules and criteria for making decisions, rather than relying on gut instinct or emotion.
This can help to keep traders focused and disciplined, and can prevent them from being swayed by biases.

Another effective strategy is to regularly review and reflect on your trades, looking for patterns and identifying any biases that may have influenced your decision-making.
This can help to improve your awareness of your own biases and can enable you to make more objective and rational decisions in the future.

For that, not only I journal daily my trades but also the emotions I felt when I took those trades.

Overall, cognitive biases can be a major challenge for traders, but by being aware of them and taking steps to mitigate their effects, traders can improve their performance and increase their chances of success in the market.

Thank you for your reading and support as always
Dave