Are You A Slave To Your Cognitive Bias?
The success or failure of any Forex trading scheme ultimately comes down to one thing and one thing only… decision-making. The FX world moves incredibly quickly and you’ve got to be able to respond in kind, otherwise your trading career will be over before it’s even begun.
But have you ever wondered what, if anything, leads us to make specific decisions – and is there anything to be done that could improve your decision-making to really drive your successes on the trading floor?
The psychology of choice certainly makes for interesting reading and it can prove really beneficial for your trading game to sit down and work out exactly what you think is motivating you to make different decisions… and what could subconsciously be making you lean in one direction or another.
We’re bombarded with a lot of information every single second of every single day, but our brain is only able to process a tiny amount of it, so we’re helped along in our decision-making by what are known as biases.
These are an inevitable part of what it means to be human and they can either be quite useful or they can cause us to make cognitive errors, so it can be helpful to give your decision-making processes a review from time to time to see if there’s anything holding you back.
There are two types of bias in psychology: Conscious or explicit bias, and unconscious or cognitive bias.
With conscious bias, you know what your feelings and attitudes on a subject are and you conduct your relative behaviours with intent. With cognitive bias, you’re not always involved in the process, with your subconscious essentially making your decisions for you.
On the one hand, what’s useful about cognitive biases is that they can help rid you of the burden of making the decisions in the first place, freeing up your mental load and allowing you to make choices relatively quickly… which is great from a trading perspective, because the environment can turn on a dime and you need to be able to react accordingly – and trust yourself to be able to take decisive action as and when it’s required.
However, these cognitive biases can also prove to be far more of a hindrance than a help, if our decisions are being prejudiced by unconscious attitudes, values and beliefs. This is where emotion can start to overtake reason in decision-making… and this could see you hit a slump with your trading ambitions if you’re not careful.
There are different types of cognitive bias that could potentially be influencing your success, but familiarising yourself with them could give you the tools you need to make changes to your reactions, decisions and behaviours. Here are some of the main cognitive biases to get to know.
Confirmation bias is what makes us unable to look at our current set of circumstances in an objective way. We spend our time seeking out data and information that confirms what we believe to be true, without seeking out sources that could potentially challenge these thoughts and ideas.
For traders, this is clearly problematic and can see you cutting winners way too early or refusing to give up on losing trades, despite the cold hard facts presenting themselves to you right before your very eyes.
You’re sure to have your own opinions as to what’s going on the market and that’s great. It’s as it should be. But you can help keep your confirmation bias well under control if you make sure you seek out the opinions of other analysts as well, as this will help you gain an unbiased impression of what’s going on.
This one is an interesting one! Attribution bias is when we decide who or what was responsible for any particular outcome. For traders this could be attributing a series of wins to your unrivalled skills as a trader, but attributing your losses to external factors, whether that’s market unpredictability or sheer bad luck… as long as it has nothing to do with you!
Being overconfident can have a huge impact on how you trade. After all, we all know that emotions are the devil’s work when it comes to trading and you’ve got to keep them all in check, even when you’re doing well. Or especially when you’re doing well!
If you think you’ve fallen into this particular trap, adapting your trading strategy can help you avoid any potential fallout. Take a look at the different products you trade and see which ones you dedicate the most time to. Are they your best performing trades or are they falling short of the mark?
If they’re doing incredibly well, try to decipher why that could be and see if you can then take this knowledge and apply it to your other stocks. Post-trade analysis is always a good move if you want to upskill as a trader and you’re sure to see improvements soon if you start carrying out regular reviews.
As problematic as being overconfident can be for traders, being nervous, not trusting yourself and not sticking to your trading plan can also have an impact on your trading career.
Herding bias is often referred to as ‘sheep mentality’, referring to making decisions based on what others are doing, even if you know deep down you should be sticking to your guns.
It can be very difficult not to second guess yourself when the majority of other traders start reacting in a certain way, of course. It makes you think they know something you don’t… which is how you end up joining the herd.
So what can be done? Well, sticking to your trading plan and having faith in your own analysis is really the only way to beat this particular bias. If everything points towards a certain direction, it makes sense to go in that direction, even if a large group of traders seem to be doing something completely different.
Doing this means that, even if you’re wrong, it still represents an excellent learning opportunity and you can actually work out any issues with your trading strategies. If you just blindly follow everyone else for no discernible reason, you won’t be able to gain anything much of value from the situation, regardless of whether you win or lose.
Habitually successful traders will make sure that they factor in historical data when analysing trading markets, making their decisions based on a wide range of different criteria.
If you don’t do this, you put yourself at risk of falling foul of recency bias, where you end up making decisions based on a very recent event, rather than adopting a more holistic viewpoint.
The impact of recency bias can be huge for traders and a trading journal can help you keep on top of it all, tracking your performance over time.
A solid trading strategy is also a must, so you can keep your goals at the forefront of your mind and what your plan is to achieve them. This will help you keep your emotions in check and ensure you approach your trading with nothing but a clear mind.
We’ve said it before and we’ll say it again… successful trading means leaving your emotions at the door. The endowment effect can be a big problem where trading is concerned, when you become emotionally invested in a particular stock or trade.
This can be because the trade in question has some kind of personal significance for you, which then leads you to value it more highly than you might have done otherwise. This can result in you clinging on to something and continuing to persevere with it, even if it goes against your overall investment goals or risk tolerance levels.
To avoid this particular mental trap, keep up to date with all the latest information and developments related to your trades. You’ll be able to update your trading strategy when presented with new information… so make sure you keep an open mind in this regard.
Having a clear exit strategy in mind for all your trades can also help prevent you from falling victim to the endowment effect.
No matter what trade you’re dealing with, make sure you set some limits and restrictions in place… and make sure you stick to them, no matter what happens. Trust yourself, trust your analysis and you should see more wins than losses over time.
Are you considering joining a Forex funding program? With FTUK, you can trade whenever and wherever you like. All you need is an internet connection and you’re ready to roll. You’ll enjoy immediate funding and can hit the ground running with our capital. We also cover trading losses and reward all those who implement solid risk control.