Confirmation Bias

Confirmation Bias is the tendency to seek out information that supports your beliefs and ignores information that contradicts them. This can cause a lot of traders to hold “bad” trades. They only seek for information that will justify their actions. This can create damaging effects as the trade spirals out of control.

Familiarity Bias

Traders tend to favor what they know, such as domestic and locally based companies. This can cause us to give way too much credit to prior successes and far too much negativity toward prior failures. In trading, doing what makes you feel uncomfortable is more often the best approach!  Familiarity Bias is very common for beginning stock and option traders. Sticking with one familiar strategy or one familiar stock stifles the growth and overall returns of that trader. A trader is much more likely to trade a stock they recently made money on, thinking this will somehow increase the odds of success. This creates the false narrative that traders “know the stock” and “understand how it moves”. These beliefs will pre-determine how the trader will react if it doesn’t go in their direction. This can cause a lot of stock and option traders to enter “bad” trades, which is at the heart of Trading Psychology. A trader must always be challenging their outlook with critical thinking and trading psychology. Familiarity bias creates damaging effects as trading mistakes are repeated

Recency Bias

Recency Bias convinces us that a rising or falling stock price will most certainly continue. Traders tend to put too much emphasis on recent events. This bias will create natural changes in sentiment during bull and bear market cycles. In addition, a trader is much more likely to trade a stock they recently made money on, thinking this will somehow increase the odds of success. This creates the false narrative that traders “know the stock” and “understand how it moves”. These beliefs will pre-determine how the trader will react if it doesn’t go in their direction. This can cause a lot of traders to enter “bad” trades, which is at the heart of Trading Psychology. They only seek for information that will justify their actions. Recency bias creates damaging effects as trading mistakes are repeated

Anchoring

An irrational bias towards an arbitrary benchmark figure or something that might be entirely irrelevant to our trade. When we use anchoring, we are naturally inclined to want to find a great bargain as we’ve been trained our entire lives to hunt for bargains. Or we will avoid seemingly high prices in order to avoid paying too much. This anchoring can create added risk or missed opportunities. This can cause a lot of traders to enter or hold “bad” trades, which is at the heart of Trading Psychology. Challenging your beliefs and anchoring is an important part of Trading Psychology. Anchoring creates damaging effects as the trade spirals out of control.

Herd Behavior

A behavioral instinct where people join groups and follow the actions of others. People naturally feel that there is strength in numbers. Herd instinct at scale can create asset price bubbles or market crashes via the panic of buying and selling.  Do you watch what other are doing before a trade? Do you read message boards before a trade? Do you wait for others before your trade? We all face moments of hesitation, especially when future outcomes are unclear or don’t meet with our expectations. As humans, we are much more likely to follow others than make a trade ourselves. In fact, studies show if we are told what to do, we are more likely to follow those orders than make independent decisions. Herd behavior is the clinical term for exactly this behavior. The ultimate irony is that we NEED to enter trades where there are more buyers than sellers (the herd) in our direction to make money on the trade. However, we need these decisions to be independent and follow proper technical analysis, not herd behavior. Challenging your beliefs and hesitation is an important part of Trading Psychology. Herd behavior is actually a positive until the cliff approaches. Learn when to follow herd behavior and when to forge your own path.

News Cycles

The financial markets are moved from the news of all sorts.   Markets are constantly searching for more data for investors and traders to make prudent decisions for their money.  Traders are also always on the lookout for news that gives them information before it’s well known.   Following and hunting news is a sure way to let emotions creep into your trading.  Isn’t it amazing the amount of news every day perfectly fits the newspaper? In this Trading Psychology Corner, we discuss Known knowns vs Unknown Unknowns and how they affect the market. The news cycle constantly puts out story after story which can affect your trading psychology if you aren’t aware. Known knowns in the news cycle are likely already priced into the market and these are times where people are confused. Why did the stock go down after good earnings? If those earnings were already expected to be good, people bought it previously before the news cycle was out. Unknown Unknowns are the dangerous ones and are referred to as black swan events. There is no way to protect yourself from these news cycles and you must be on your toes as a trader. The news cycles will amplify this event, causing massive moves in both directions.

Hesitation

We all face moments of hesitation, especially when future outcomes are unclear or don’t meet with our expectations.   Simply put, hesitation is simply fear of the unknown.   If a trader has come to terms with ALL the possible future scenarios, they can bypass hesitation as everything has been planned (the loss) and accepted.  Do you hesitate before a trade? Do you chicken out before a trade? Do you have doubts before your trade? We all face moments of hesitation, especially when future outcomes are unclear or don’t meet with our expectations. Simply put, hesitation is simply fear of the unknown before a trade. If a trader has come to terms with ALL the possible future scenarios, they can bypass hesitation as everything has been planned (the loss) and accepted, before the trade. Challenging your beliefs and hesitation is an important part of Trading Psychology. Hesitation before the trade creates damaging effects as the trade spirals out of control.