Even the most rational individual is vulnerable to biases and prejudices – an investor is no different. Regardless of how disciplined an investor might be, often times trading biases affect his/her trading decisions more than the available empirical data. This in turn, leads to inferior returns as against the market benchmark. On the other hand, investors who have a strategy on how to avoid them are more likely to earn more from their investments and stock market trading.
Here, we highlight five of the those trading biases and methods to avoid and overcome them –
1.Herd Mentality Bias – Trading Simply Because Others are Doing
You don’t know whether you should place your trades or not but simply because others are saying ‘so’, you trade.
How to avoid Herd Mentality Bias?
Focus on Research: Do not trade listening to the market tips and rumors. Those should be taken in account during your research time, not when you trade. Make a smart trading strategy based on your thorough research data and place your trades accordingly. Trading based on data and research will save you from capital erosion which happens when you trade based on herd mentality bias.
2.Confirmation Bias – Dismissing Any Conflicting Inputs and Sticking to Pre-Occupied Notion
Here, you tend to stick to your data, theory and information that validates your point of view and simply tend to dismiss any inputs/notion that conflicts your reasoning.
How to avoid Confirmation Bias?
Look out for Contrary Views and Data: Don’t ignore the contrary views and/or the other side of your trading assessments and interpretations. In addition, your trading decision has to be based only after assessing the contrary views, readings and understanding.
3.Gambler’s Fallacy – Taking Chances
This trading bias is the fallacy/misconception that ‘something’ that has not happened for a long time can/will happen now as it is long ‘overdue’.
How to avoid Gambler’s Fallacy?
Focus on Analysis: The outcome of the trade is not based on ‘probability’ which is why as a trader, you must always place your trade purely based on research, technical as well as fundamental analysis and logic, not assumption.
4.Performance Chasing – Chasing Trends
Many of us have a tendency of finding a pattern, acting up on it and even weighing our decisions on that pattern. However, a pattern of past performance or a list of historical achievements can never be the basis of the future result.
How to avoid/overcome Performance Chasing?
Take responsibility: In order to succeed in the long run and earn profits from trading you can’t chase trends. You need to be responsible and stop chasing yesterday’s winners and getting away from recent losers.
Too much information, data, news and opinion from indicators. Individuals and expert comments can create a lot of confusion in your mind – leading to over-analysis, over-thinking and finally a certain bias that would lead to inaction from your end.
How to avoid/overcome Over-Analysis Fallacy?
Make a trading plan and stick to it: In a rule-based manner, make your trading plan and stick to the process and stay away from too much noise.
Most trading biases are quite natural and that is what makes it dangerous, if not fatal. No wonder, it not only affects your investment decisions but also your ability to achieve maximum profits. However, good thing is no matter what biases you form, with practice and effort you can get rid of them.
Also Watch: How to Trade With Angel Broking