Nobody is 100% rational: all of our decisions are influenced by the way our minds have evolved over time. As a result, we often make wrong decisions in trading and investment that are based on emotion, leading to preventable losses.
It’s a long post, so it’s best to bookmark it and use it for reference. Being aware of these biases will help you to trade with less emotion and more discipline, and to be more consistently profitable, hopefully 😄
People want to avoid losses more than they want to make profits.
Often traders are reluctant to sell assets that are deep in the red, because that would mean realizing a loss. Instead, they hope that they’ll go up again at some point.
Similarly, greedy traders who are prone to this bias will sell winning positions to quickly avoid any potential losses that might happen if the market suddenly moves against them.
“Now that I’m down 90% I might as well keep these bags or I’ll beat myself up when they pump.”
“Wow, this stock is up $500 since I bought it, I should sell it before it drops again.”
How to avoid: have a plan for when you are going to take profit or cut losses and set appropriate orders for short-term trades.
Investors often irrationally value an asset more highly, simply because they already own it. This shadows the actual picture and often leads to missed opportunities.
How to avoid: try to think about the asset independently. Would I buy or sell at this price if I didn’t already have it? Act accordingly.
People (especially gamblers) often make decisions based on the outcome (winning at roulette) and not on the process (getting lucky with 37-to-1 odds) that led to that outcome.
“My friend got rich by buying this asset, so I better buy it fast.”
“I never sold BTC in 2013 and that worked well. I should just never sell BTC.”
How to avoid: remember that the outcome (e.g. making a profit from a specific asset) is the result of a process (buying and selling at the right time). Don’t blindly copy a strategy that worked for somebody in the past. Instead look for the factors that led to that outcome.
People group money and assets into different mental accounts: “this is for long-term investments”, “this is spending money”, etc. Money is still money.
This could lead to excessive risk-taking, for example if you have some ‘play money’ gained from successful deals and then keep making high-risk trades with that money.
Or you might have a separate ‘hold’ fund that you never sell. You don’t then rebalance the whole portfolio and might once again take on extra risk by being overexposed to your favourite asset after it rapidly appreciates.
How to avoid: understand that money is money and evaluate your whole portfolio without dividing it into subaccounts.
People think they can control outcomes even when they cannot.
When an exchange has a slick interface and it’s easy to use advanced order types, people tend to make too many trades just because they think they’re in control. That’s exactly what exchanges want — more commission fees!
How to avoid: remember that you can’t control the market or even your positions — there has to be someone on the other side for any order to be executed.
People tend to credit their own skills when winning and blame their failures on something else (a bear market, whales, the government, etc.).
Everybody is a genius in the bull market. This illusion might cause traders to trade too much when profitable or otherwise fail to learn from past mistakes.
How to avoid: value failure and learn from every mistake. You’re the one who has made every decision, including the bad ones. The more mistakes you make, the better the trader and investor you will eventually become.
To avoid having any regrets, investors might not take any action at all.
This is where you don’t sell your bag to avoid beating yourself up if in case it bounces.
Also, to avoid the regret of missing out on a bull run, people can end up buying mooning assets without doing the proper research.
How to avoid it: understand how regrets have affected you and your past investment decisions (e.g. did you FOMO buy or hold on to bags?) and take this into account when evaluating your next investment.
People tend to evaluate more and more information even when it doesn’t contribute to making a better decision.
You might keep reading Reddit posts, watching YouTube videos, and scrolling through Twitter, but will this really affect the probability of making a profitable investment?
How to avoid: understand that most commentary is useless and that often less information leads to better predictions.
Talking to pilots who’ve returned from a dangerous mission alone won’t reveal all of the risks. Those who have perished are not there to tell their stories.
In the market, the outstanding performance of Lambo-driving traders with 10x leverage is undoubtedly impressive. Yet there are far more of those who have lost their deposits and rarely talk about it on social media… and even if they do, hardly anyone follows them. This can lead to excessive optimism because failures are ignored or are not reported.
How to avoid: when evaluating instruments and opportunities, think of what is not being included in your selection — these omissions might be hiding risks.
People often act against their long-term interest because they simply can’t control their emotions.
Everybody knows that to lose weight they should eat less and exercise more, but emotions get a hold on us and we eat that piece of cake…
Similarly, most investors know that dollar cost averaging usually works better than trying to time the market to enter in a single large trade. Yet it’s easy to simply delay investing because “the crash is coming soon” and you need to buy a new pair of sneakers today.
How to avoid: realise that you’re probably overestimating your ability to control your emotions and instead create a coherent strategy to determine your actions.
These are just some of the psychological biases that affect our thinking. Usually none of them exist in isolation and instead they interact in a myriad of ways that can cloud your judgement.
Let’s gather more insights by sharing our experience, tips and resources in the comments below 🙌.