1. Fear of missing out (FOMO)
This social anxiety gives us the desire to stay continually connected with what others are doing. This anxiety is also connected with the fear of regret. One way to solve this problem is to think that, as the businessman Richard Branson..
…opportunities are like buses, there’s always another one coming.
2. Confirmation bias
This is the tendency to search for information that will confirm what we already believe. For example, if we believe that company ‘X’ is going to default, we will ‘see’ only the information that verifies that, although the opposite might be true. One way to bypass this bias is, as Charles Darwin did, to practice recording evidence against and both in favor of your argument.
When we are overconfident, we misjudge our capabilities, also relative to others, and we might expose ourselves to greater risks. The best way to attack this bias is to strictly follow our written trading plan. This will keep us in check with our abilities. Also, when we keep a trading journal, we can analyze our past performance and correct our trading plan based on pure data.
4. Loss aversion
This effect derives from cognitive psychology. When a trader has loss aversion, then he or she has the tendency to prefer avoiding losses. When a trader loses $100, it will have a greater effect on his or her psychology than when he or she gains $100. A way to win the battle against this behavior is to keep a detailed trading plan and a detailed trading journal. Then we must use the tighter risk management and just follow our statistics.
5. Negativity bias
Negativity bias means that one will put more weight into negative news rather than try and weigh the information. Information should be weighted and analyzed with logic and without pre-taking any positive or negative side.
6. Paradox of choice
Every month, a new company does its IPO, a new crypto coins its ICO, etc. A trader needs to choose between thousands of strategies, financial products, etc. The only solution that keeps us from being all over the place, and not having one effective way to trade the markets, is to take these choices away from us. Again, a trading plan and a trading journal will be the solution to this behavioral bias. When we need to change our strategy, we need to first paper trade for a year and check the statistics afterward.
7. “Popular prescription” bias (Bandwagon effect)
How many times have we heard…
If this was working, everybody would be a millionaire.
Again and again, studies have proved that the perception of the crowd is not always right. In his TED talk, Paul Rulkens will explain to us why the majority is always wrong.
One quote that we could take from this talk is…
If we follow the norms, we get the results that everybody else is taking.
Let’s do ourselves a favor and start an information diet. Let’s ignore the noise of the information age and forget what everybody says, but instead focus on our data, plan, goals, and living standards.
8. The thrill of the new
Until 2007, the world had never heard about Instagram, the iPad, Bitcoin, Tesla cars, WhatsApp, and Uber. These are just a bunch of technologies that right now are a part of our daily lives but didn’t exist some years ago. On the other hand, some statistics suggest that 70% of small businesses fail in their 10th year. There were 70% more products that never made it into our lives. Everything new has a risk, and the newer the product, the greater the risk. So if your risk tolerance is high, then you might be able to try new things. For the majority, we need to stay away from the new things and stay in sync with our risk tolerance.
9. Anchoring bias
Not every information is created equal, but this does not mean that we are allowed to misjudge. Anchoring bias refers to the individual who depends too heavily on a piece of information that anchors all of his or her decisions. Again, we need to stay intact with our trading plan and use the above-mentioned techniques, so that we will rely more on data than personal opinions.
10. Revenge trading
The alpha and the omega of trading psychology is to understand our risks. Trading has risks, and so do everything in life. If we decide to go out today, we might have an accident, we understand the risk, and we take it. In trading, one will certainly have red days, this does not mean that on the next day, he or she will have to double the risk in order to make back the lost resources. This behavior will lead us to emotional trading and misjudgments, and as the common theme of this article is, we need to stay away and follow our prewritten plan.
11. Real account vs demo account
The final mind trap for traders is that they trade for way too long in a demo account. Humans are emotional creatures. We never know how we will react emotionally in a situation. If we paper trade, we put ourselves into a controlled environment. We will not have an emotional connection with our ‘hard-earned money’, whatever this means for everybody, and thus we won’t feel every loss in our bones. As a businessman cannot learn how to manage a business by playing video games, and a pilot from a simulator, we need, sooner or later, to expose ourselves to the risk and emotional pressure of the real world.