You and your bias

A cognitive bias is an unconscious error in thinking that results from our brain’s efforts to simplify the complexity around us.

The concept of cognitive bias was developed in the 1970s as a framework to identify and analyze the predictable mental errors that induce illogical and irrational decisions.

Most people that lose money in trading suffer from a cognitive bias that makes them misjudge risks and undervalue threats.

In trading, the only cognitive bias you can have is the belief that anything can happen.

I find this topic so interesting, and also so valuable for self-assessment, that I use this article to typify the most common types of cognitive bias (if you dare, find the ones that most affect your behaviour):

1.??Confirmation bias

This happens when you selectively look for information that can support your preexisting beliefs, discarding all data contrariwise to the point you want to prove. I confess that this happens to me all the time when I am trading. The strategy I use to overcome it is a double or triple confirmation. If the KPI’s I use give me mixed directions or confuse me more than they help me, I just sit on my hands.

2.??Anchoring

This is also known as the “first impression bias”. It’s the tendency to jump to conclusions, making a decision without having a complete view of the problem or without considering all available information. This happened a lot to me when I started trading forex because I had preconceived ideas about the value of currencies and would go short or long based on those beliefs. I overcame this predisposition with time but a good option is to trade the “not so obvious” currency pairs (for instance SEK/DKK: Swedish Krona to Danish Krone) so you can focus on the charts and forget your opinions.

3.?Overconfidence bias

This happens when you place too much faith in your own knowledge and opinions. Maybe it will be no surprise for you to know that entrepreneurs are more likely to display overconfidence bias because they have a lower risk perception. I, personally, make more mistakes after 2-3 trades with a profit because I fell like I “nailed it” and I’m domineering the market. Needless to say, markets cannot be controlled…?

4.?Halo effect/ Horn effect

This is the tendency to believe that someone you like or trust in one context could not be wrong in another context. The Horn effect is the opposite of the previous bias. It happens when you don’t trust someone so you would never consider his/her opinion in any topic.

5.?Gambler’ s fallacy

This happens when you expect past events to influence the future. It is true that patterns occur but, regardless, outcomes are always uncertain. The number of successes that you've had previously have little or no bearing on the future.

6.?Fundamental attribution error

This is the tendency to place blame on external events or to blame someone else, instead of looking objectively at the situation. In trading its very easy to blame the market when you lose, never admitting a bad judgement, a bad timing or an inconsistent calculation of the risk reward ratio. The truth is, either you lose or win, you are the only responsible for your results.

7.? Bandwagon Bias

This bias is related with group think and happens when you form an opinion based on others’ opinions. Most trading platforms I know have some sort of scale that tells you the percentage of traders that are buying or selling each asset. When I started, I used to look at those stats to confirm if my interpretation of price action was in line with the “crowd”, but sometimes it didn’t, and that mismatch would made me insecure. I sometimes missed the opportunity to win money because I went along with the movement so now I never look at that data.

8.?Mere exposure data

In decision making, this bias can manifest itself as a preference for opinions, people, or information that you've already seen or heard before. There are loads of traders giving their opinions, lessons and tips on social media. Please do not chose a guru or virtual mentor! It is preferable to have an open mind, grow your knowledge and build your own informed, exclusive and personal opinion.

9. Hindsight Bias

Also called the "I knew it all along" effect. It happens when someone believes that they accurately predicted the outcome of a decision before it was made. It is quite easy to foresee a certain outcome after the event has taken place but it's quite annoying to be an "I told you so" kind-of-person.?

10.?Dunning-Kruger Effect

This bias refers to people's ability to accurately assess their own and others' competence. In general, low-skilled people tend to overestimate their own abilities, and highly skilled people tend to underestimate theirs.