To become a better trader, start by understanding yourself first. You can do this by knowing your tendencies to help you navigate your trades more effectively.
A big tendency we have are called "cognitive biases".
Cognitive biases are flawed ways we perceive the world, often designed to boost our confidence rather than reflect reality.
For instance, the "sunk cost" fallacy occurs when traders hold onto losing positions because they've already invested significant time and money. They hope their fortunes will reverse, ignoring that past losses cannot be undone.
Smart traders focus on current market conditions rather than past investments.
Here are other common cognitive biases in trading:
- Recency Bias: Giving more importance to recent trends over long-term data.
- Anchoring Bias: Fixating on initial information or prices that may not reflect current market realities.
- Confirmation Bias: Seeking information that supports existing beliefs while dismissing contradictory evidence.
- Overconfidence Bias: Overestimating trading abilities, leading to excessive risk-taking.
- Herding Behavior: Following the crowd without independent analysis.
- Loss Aversion: Preferring to avoid losses rather than seeking profits, often leading to prolonged holding of losing positions.
- Availability Bias: Overestimating the importance of easily accessible information.
- Gambler's Fallacy: Believing past losses predict future outcomes.
- Endowment Effect: Overvaluing assets simply because they're owned, leading to reluctance to sell.
- Framing Bias: Making decisions based on how information is presented rather than its content.
Recognizing and managing these biases and tendencies is crucial for making informed trading decisions and avoiding suboptimal outcomes.
"The more you learn the more you earn"
(Warren Buffett)
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