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Biased trading can result in wrong decision-making and influenced judgement. It becomes indispensable to familiarise oneself with these common trading biases and get rid of them before they start affecting your trades negatively.
In this article, we discuss the top common trading biases and what you can do to prevent them:
1. Overconfidence bias
The overconfidence bias is one of the most common biases to exist. In this, traders become overconfident about their talent, belief or skill and take decisions based on not facts but an inner feeling of surety. This leads traders to a loss of control while trading, because traders are blinded by their overconfident behaviour, resulting in unsuccessful trading decisions.
Traders can overcome the overconfidence bias by reflecting on their mistakes gravely, keeping an open mind to trades and only basing their decision on market facts and analysis. Traders should understand that nobody is perfect, and overconfidence can hurt their trading performance.
2. Loss aversion bias
The loss aversion bias is when traders prefer to avoid as much loss as possible instead of focusing on gaining as much as possible. In this situation, the traders decide to not sell their loss-making currency pairs, hoping that the prices will increase in the future and their losses will reverse. Such traders would rather not lose $500 worth of currency pairs instead of simply gaining $1000.
To get rid of this bias is by thinking about the investment or trade from a long-term perspective. Studying the market in this situation becomes very important as they present a future forecast picture that can help traders decide more sensibly. If the market portrays a downturn in the currency pair traders are holding onto, it is best advised that traders should get out of the trade and take the existing losses instead of waiting for the markets to recover.
3. Confirmation bias
The confirmation bias is a method of traders seeking any piece of information that confirms the existing market condition so they can decide on the basis of the same. This leads traders into making colossal investment and trading mistakes as the information makes them overconfident about the future market results.
Getting rid of this bias requires traders to challenge their trading decisions as much as possible. In this situation, traders must question each and every step they take in the trading process and analyze where they can go wrong. This will help them see all possible pain areas in the trade decision and trade accordingly.
4. Incentive bias
The incentive bias leads traders to make their trading decisions based on the power of incentives and rewards. At times, when traders are given a particular incentive to trade a security, their trading decisions are not based on facts but on greed. This leads to an improper trading decision.
To get rid of the incentive bias, traders should manage their emotions rationally and not fall prey to incentivized deals. Instead, they should focus on the market sentiment, price analysis and future predictions to make any trading conclusion.
5. Hindsight bias
The hindsight bias leads traders into a situation where they consider all positive past events as predictable and the negative past events as non-predictable. In such a situation, traders start blaming unpredictable market conditions for poor currency pair performance. On the other hand, when their trades become successful, they think of it as something that was already forecasted.
Getting rid of this bias is crucial as it hinders objective decision-making powers. It can be done by examining the historical and current market data. Traders must also remind themselves that they cannot predict the future, and not all bad decisions are to be blamed on market volatility. Owning up to mistakes is essential for getting rid of this bias.
6. Anchoring bias
The anchoring bias is where the traders rely solely and strongly on past performance, reference, or information about the currency pair to make a trading decision. Traders get influenced by historical performance and forget to consider current performances and future expectations. This often leads to traders making decisions based on false information.
A trader can overcome the anchoring bias by delving deeper into currency pair’s research on its past, current and future expected performance. Technical analysis tools can be used to figure out where the security is headed, and decisions can be taken accordingly.
7. Herd mentality bias
The herd mentality bias is where traders follow a particular trade decision just because a lot of other people are doing the same. Traders copy what most famous investors are doing or suggesting to do without considering any market analysis to support the decision. Due to the herd mentality effect, traders are highly influenced by emotions and make prejudiced judgements.
Traders can get rid of the herd mentality bias by spending more time analyzing the decisions to be taken, backing up the decision with facts and figures, being aware of the consequences of the decisions made, and thinking twice before finally opting for the particular decision.
8. Self-serving bias
The self-serving bias is a one hundred percent subjective bias that makes the trader think that all positive outcomes result from the trader’s skill, and the negative outcomes are attributed to bad luck. In this situation, traders can never evaluate the real problem behind their unsuccessful trading decision. Hence, it leads the traders to make worse decisions each passing trading day.
One can get rid of this bias by attributing each and every outcome to one’s own responsibility. Traders must understand that if they take credit for positive outcomes, then responsibility for the negative ones also relies on them. Next, traders should analyze and improve the reason behind bad outcomes to ensure it does not happen again.
Get rid of the trading biases
If not conquered on time, trading biases can severely hurt a trader’s trading performance.
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