How to Avoid Being Influenced by Recency Bias

Recency bias, a cognitive bias/error, makes traders overemphasize on recent events. This can lead to impulsive decisions based on short-term trends. By focusing on the most recent information, many investors may miss out on opportunities and make poor choices. 

To avoid recency bias, it's crucial to consider a pool of different approaches, which we will discuss in this article.

What is recency bias?

Recency bias refers to the tendency of people to give greater weight or importance to recent events, experiences, or information, often at the expense of older or equally relevant data. This can lead to skewed judgments or decisions.

Example of recency bias

In forex trading, recency bias happens when traders focus too much on recent market movements. They may ignore longer-term trends or broader analysis.

For example, if the US Dollar has strengthened against the Euro in the past few days, a trader might expect it to keep rising. This overlooks the fact that the dollar had been weak for months before the recent rally.

This bias can lead traders to make impulsive decisions, potentially missing out on better opportunities or taking unnecessary risks.

How to avoid recency bias while trading

Keep a detailed trade journal 

A trade journal helps track decisions over time. Traders should record each trade, including reasoning, market conditions, and emotions. This provides a historical record, reducing reliance on recent trades. Reviewing the journal helps spot patterns and avoid recency bias. It encourages informed decisions based on full analysis, not just recent performance.

Stick to the trading plan, regardless of recent outcomes

Recency bias can lead to impulsive decisions. Stick to the trading plan, which outlines rules, risk management, and strategies. Avoid deviating from the plan after a win or loss. This ensures decisions align with the trader's long-term investment strategy, not short-term results. Consistency helps reduce emotional responses to recent market movements.

Understand market cycles

The forex market moves in different cycles—short, medium, and long. Short-term trends may not reflect the broader cycle, while medium and long-term trends give more information about the overall market. Understanding these cycles helps avoid overreacting to recent fluctuations. Recognizing market phases like bullish or bearish trends also helps traders place trades accordingly. It keeps them focused on long-term behavior, not just temporary trends, preventing recency bias from influencing decisions.

Pause and assess emotions before making decisions

Emotions can lead to recency bias, especially after wins or losses. One should pause before acting to assess one's emotional state. This helps clear the mind and avoid impulsive decisions. By making decisions calmly, traders base them on strategy, not emotion. Taking a moment ensures rational choices, free from the influence of recent performance.

Control overconfidence and fear after wins and losses

Overconfidence after wins or fear after losses distorts judgment. After a win, don't take excessive risks. After a loss, don't become overly cautious. Recognize these emotional reactions and stay balanced. Focus on the investment strategy, not emotions. Managing overconfidence and fear keeps one's trading consistent, avoiding the influence of recent outcomes.

Regularly review performance metrics

Reviewing the performance appraisal metrics helps avoid recency bias. Track data like win rates, risk-to-reward ratios, and trade outcomes. This lets traders assess long-term performance, not just recent trades. Regular reviews help identify patterns and areas for improvement. Objective analysis keeps decisions based on evidence, not short-term results.

Set and review performance goals on a weekly or monthly basis

Set clear, measurable goals for the week or month. Focus on long-term progress, not recent outcomes. Review these goals regularly to track the performance. This keeps traders focused on growth and strategy, reducing the temptation to react to short-term results. Goals help maintain a balanced perspective in trading.

Don't overreact to short-term trends

Short-term trends can be misleading. Avoid reacting impulsively to sudden price movements. Look at the bigger picture, considering long-term trends and analysis. Instead of chasing quick gains, follow the set strategy. This helps prevent recency bias from influencing one's decisions and keeps the approach disciplined.

Maintain consistent position sizing

Consistent position sizing keeps risk steady by using the same amount for each trade. This prevents emotional reactions to recent wins or losses, helping maintain a disciplined approach. Remember that after wins, avoid increasing position size excessively. Whereas, after losses, don't reduce it too much. Stick to the risk tolerance and position sizing plan. This keeps one's risk management intact and prevents emotional decisions based on recent performance.

*This is an example only to enhance a consumer's understanding of the strategy being described above and is not to be taken as Blueberry providing personal advice.

Top tips to avoid recency bias in trading

• Diversify trades: Traders should diversify their trades using different assets or strategies. This, in a way, minimizes the influence of recent market activities in their decision-making.
• Focus on data-driven analysis: It is less risky to move with technical indicators, fundamentals, and strong research rather than making trades on the basis of the latest information on price trends.
• Use risk/reward ratios: Clearly defined risk/reward ratios for each trade will help traders stay rational, specifically at moments when more recent trades have influenced their decisions.

Trading forex without the recency bias

Reducing recency bias trading assists traders in making reasonable decisions for long-term strategies as compared to short-term financial market trends. With strategic planning, the trader is able to move past a number of recent winning/loss-making trades. This results in improved risk position and actual trading flows since it avoids reckless or overly conservative conduct. Long-term view leads to the discovery of sustainable trends as well as market opportunities.