Is Anchoring Bias Holding You Back?
Every action we take in any walk of life is shaped by countless heuristics and biases that make up our intuitive decision-making, but these same assumptions that help you get through life might be limiting your success as a forex trader.
Of the many different biases that affect prop firm traders, anchoring bias might perhaps be one of the most common, but despite seeming like a rather harmless belief, it can potentially cause more damage to your portfolio and career than you might expect.
In no small part, because it is difficult to see when it is affecting your strategy, it might be the greatest limit to the potential of a trader, but also one that can be fixed by reshaping your trading strategy in a way that focuses less on the currency ticker and more on your overall strategy.
To understand why, here is a guide to anchoring bias, how it manifests in forex trading, how you can spot it shaping your decision-making subconsciously and what you can do about all of this.
What Is Anchoring Bias?
Life is shaped by biases, as they are a fundamental way in which we think and decide quickly, and one of the most supported theories about why this is the case can be found in the concept of there being two systems of thinking.
System 1 thinking is intuitive, immediate and unconscious, allowing us to make snap decisions, follow a familiar route, read signs, log into a terminal without having to consciously recall our user credentials, breathe, and thousands of other decisions we make every day without even thinking about it.
By contrast, System 2 thinking is intentional, conscious and often quite slow, requiring us to carefully consider not only the answer to a problem, but also the process in which we reach this conclusion.
Many everyday actions can switch from one to the other; many people who are first learning a skill will rely heavily on System 2 thinking to ensure they are doing everything correctly, but once it becomes second nature it becomes a System 1 skill.
Conversely, a theory behind the “yips”, “target panic”, “twisties” and “dartitis”, four sport-specific terms for the loss of fine motor skills during routine actions such as putting in golf, serving in tennis and throwing darts, is that these actions are undertaken consciously using System 2 thinking rather than System 1 thinking, causing overcorrections in high-pressure situations.
This all serves to illustrate that System 1 thinking is something far beyond recklessness or impulsiveness, but instead is a vital part of how we make decisions, but there is a double-edged aspect to the speed of thought.
Whilst it allows for very quick decision-making, these choices are based on a lot of assumptions, which are not always going to be correct.
The most common of these is the anchoring bias, which is where a single piece of information is prioritised and focused on when making a decision, such as first impressions, initial price or presentation.
Whichever initial factors become the anchor of a particular belief will shape decision-making later on.
This bias is a key reason why first impressions matter so much when meeting someone either personally or professionally; that first encounter will shape the perspective of the rest of the relationship and any decisions where this relationship is a factor.
For example, people are typically more likely to try and maintain a long-term relationship if the start of it had very positive memories attached to it, even if said relationship has become decidedly more harmful over time.
It is commonly used advantageously by retailers to make products and sales seem better than they are; if you see that an item is priced at £40 but the next time you see it has gone down to £20, it will look like a much better deal than if the same item was initially sold for £20, even if its actual value is closer to £20 than £40 if viewed analytically.
What Can Affect Anchoring Bias?
Like most heuristics, it is an aspect of emotional trading, with various personal factors affecting how vulnerable people can be to anchoring.
Someone who does not have a lot of experience in a particular field is more likely to rely on the little information they have available to them, making them prone to anchoring bias.
Meanwhile, personality traits such as closed-mindedness and stubbornness can lead someone to believe that the information they already have is enough to make a reasoned decision.
Finally, mood is a key critical factor, people who are stressed, sad, angry or otherwise in a generally negative mood may be more inclined to make snap decisions using anchoring.
How Does Anchoring Bias Affect Forex Trading?
Once you have a general impression of how common anchoring is, the next question is invariably about how it affects your forex career, and ultimately it can worm its way into nearly every trading decision if you let it.
When many traders start out, the currency markets can be extraordinarily complex, with so many different data points available to a trader as soon as they gain access, which means that a trader who jumps in at the deep end is going to base a lot of their trading activity on the first pieces of information they see and judge performance based on that.
A somewhat simplified example of this is buying a currency pair at a given price and assuming that price is a neutral norm, even if it turns out to be the peak or the valley of a given asset’s price.
Buying in without doing a lot of research first could give the mistaken impression that the purchase price is the baseline and potentially either sell a pair too soon after making only a modest gain that could go higher or wait to sell a currency pair that has peaked and lose far more money than if a stop loss order had been placed.
It also causes either overreactions to sudden activity in the market or conversely misses a sign that there has been a major change in market conditions because the basis of the trading strategy is a limited pool of old information rather than continuing research and analysis of a portfolio.
It can also lead to an emotional attachment to your buy price, meaning that some traders in a bear market might stubbornly close a position because they do not want to “realise their losses”, denying reality in the process.
As with other forms of trading bias, the two main driving emotions of fear and greed both affect anchoring in different ways, and both can lead to a trader losing considerable amounts of potential or actual money in the process.
There is the story of a celebrity stock picker who claimed to have an “unbeaten record” of choosing stocks. However, the sleight of hand he used to get that “record” how meaningless “wins and losses” in financial markets are, especially in forex.
The story of Lenny Dykstra’s stock market career is somewhat infamous, but the short version of his strategy is that he would pick stocks and make all of his trading decisions based on anchoring.
As soon as the stock price ticked above his initial purchase price, he immediately sold, whilst any stock that was trading lower than his original buy price he kept, losing huge amounts of money in the process, contributing to his later bankruptcy.
How Do You Stop Anchoring Holding You Back?
Once an anchor has its hooks in you, it can be difficult to let go and examine the market objectively as it exists, rather than relative to the initial point of reference.
However, it is not impossible to break the hold anchoring has, and for many traders, it is the first step from being a beginner on the market to making trading their career.
The first step is to accept that everyone has been vulnerable to anchoring at some point in their trading career. There is no shame in wanting your picks to do well, as long as you have the perspective to get out of a position when it is clear that it won’t.
A lot of anchoring comes from limited understanding and experience with the vast web of data that makes up the forex market, and the best way to fix that is with experience and learning.
Ultimately, it takes a lot of time to know how to effectively interpret all of the data you have available, sort out good information from bad, and understand how to tell the difference between a trend and an aberration.
Spend a good chunk of your trading day not trading at all but following the market and working on your trading plan.
Focus always on the long-term trend and the overall goal, rather than the moment-to-moment random noise of the market and the record of individual trades. Many traders have dozens of losing trades that are wiped out by a well-planned successful one, so avoid taking each one so personally.
Stay positive in general, mindful of your thoughts and more objective in your decision-making.
Setting up a trading plan can help here, as it allows you to dedicate time away from the market to setting up an approach that harnesses System 1 thinking far more constructively and effectively.