There is a famous quote by F. W. Boreham on decision-making that one should always admire –
“We make our decisions…and then our decisions turn around and make us.”
Decision-making is a vital skill, especially while trading.
In an instant, you could lose it all by making the wrong choices.
Now let’s come straight to the point – Trader and his/her Behavioral Biases while trading!
Rather than choosing a rational and objective approach, traders tend to use the emotional and irrational side of the brain while making decisions under pressure.
As the volume drops… as the red candles start dominating… the mind starts deviating from the logical path landing towards the emotional one.
In such a case, the inner sentiment takes over the decision-making process.
I feel it is essential to share with you, the two most common behavioral biases a trader goes through when making decisions at the hot seat:
As we know that an anchor is a heavy object which is thrown to the bottom of the sea preventing it from deviating position and remain stabilized.
Under the same notion, we can define Anchoring Bias too.
During the decision-making process, people anchor themselves to their previous knowledge they have had around the topic.
Further decisions are made in reference to the older one.
When it comes to traders, if the trader sees a stock which is running at a price lower than its 52-week low, he may take up the 52-week low price as a standard and hence purchase the stock at a lower price to that.
Here if the actual rationale is something relevant to the overall market, then he goes right, but if it’s not the case, certainly he will have to suffer substantial losses.
“I knew it all along” is Hindsight Bias in a sentence.
Traders tend to act as if they knew that this event was inevitable.
Once the prediction goes randomly correct, they are anchored to that wrong belief and expect the same to happen in the future too.
As the trader keeps on winning trades with such hindsight biases, he takes the game of randomness to the riskier side with bulk trades.
This happens because he/she starts feeling that he/she possesses superior predictive abilities and must win the trade.
Impulse decisions become constant, and the full impact is only felt at the end, after huge losses.
How do I avoid these biases?
One way to avoid these biases is to keep a diary of yourself.
Make a note of the emotions, analysis, and every rational decision you applied while executing the trade.
Then go back and study yourself.
Then question if any choice of yours was subjected to facts or any random prediction?
Try correcting yourself and follow the objective approach henceforth.