Various Cognitive Biases Faced by Traders

Cognitive biases refer to a deviation arising from mental shortcuts that the brain uses to process information. Several cognitive biases that can influence the decision-making process include:

1. Confirmation Bias: Traders often focus on information that supports their existing beliefs, and ignore contradictory evidence. This confirmation bias can lead to opting for notions causing flawed analysis and trading decisions.

2. Overconfidence Bias: Overconfidence bias occurs due to trader’s overconfidence in their abilities and market knowledge. This can lead to excessive risk-taking, poor risk management practices, and ignoring market uncertainties. Pride and attitude are two pillars of overconfidence.

3. Anchoring Bias: Anchoring bias occurs when traders anchor values while making decisions. Traders may anchor their price targets or stop-loss levels based on outdated information, rather than adjusting them in response to new market developments.

4. Loss Aversion: Loss Aversion refers to the tendency of traders to experience the pain of losses more acutely than the pleasure of profit. Traders may become overly cautious of risks, hesitating to cut losses or take necessary risks to achieve their trading objectives. It is being over-conscious about losses.

5. Herding Bias: Herding bias occurs when traders follow the actions of the crowd rather than conducting independent analysis. It is like acting as the cattle who follow other cattle blindly. This can lead to momentum trading strategies based on market sentiment or social proof, without considering underlying fundamentals or risks. It refers to the tendency of humans to follow the crowd.

6. Recency Bias: Recency bias occurs when traders pay more attention to recent events or trends than historical data or long-term market fundamentals. This bias can lead to overreaction to short-term market fluctuations and neglect of broader market trends or patterns. It affects the analytical skill of the trader.

7. Framing Bias: Framing bias occurs when traders’ decisions are influenced by the way information is presented or framed. Traders may interpret the same information differently depending on how it is presented, leading to biased decision-making. This may lead to misguidance.

8. Availability Bias: Availability bias occurs when traders overestimate the importance of information readily available to them while underestimating less memorable information. It means information easily available is considered less important. This bias can lead to skewed perceptions of risk and opportunities in the market.

Trading psychology is the mental and emotional factors that influence a trading decision of an investor. Such factors include emotions, cognitive biases, fear, greed, hope, risk tolerance, discipline, and self-control, which affect the trading decision and risk management analysis and strategies. Trading psychology has a significant impact on a trader’s ability to plan and successfully execute a sound trading strategy. The psychology of a trader plays an important role in making rational decisions, managing risk, and achieving long-term goals. Self-awareness, emotional balance, and a progressive mindset all reflect a strong trading psychology. However, traders can attain strong psychology through mindfulness, visualization, journaling, and seeking support from others (mentors or trading communities). A trader’s ability to understand the complexities of the financial markets highly depends on trading psychology.

Geeky Takeaways:

• Trading psychology is the mental and emotional factors that affect a trader’s trading decision.
• Fear, greed, hope, risk tolerance, discipline, self-control, cognitive biases, emotions, etc are part of trading psychology.
• Trading psychology often depends upon mindfulness, visualization, journaling, and support of trading communities.
• Strong psychology and balanced emotions provide clear insight into the financial market, which facilitates a better decision-making process.