Are You A Victim Of The Recency Bias When Trading? Part 2

February 23, 2022

Are You A Victim Of The Recency Bias When Trading? Part 2

Cognitive biases can negatively affect our decision making, especially when it comes to trading and investing

Both doubt and psychological distress are part of our hypothetical trader’s reality.

In struggling with the despair of coming down from the high of a six month winning streak by posting nothing but losses for a month, she is unable to take a mental step back and assess her situation without panicking about something being direly wrong.

6. Recency bias

If she were able to, she would not have doubted her trading plan, or classified her winning streak as a “pure fluke”.

While luck will always be an important element of trading outcomes, an effective trading system is still needed to identify and take advantage of trading opportunities. A month of losses doesn’t take away from the fact that just before that, she was profitable on every trade for half a year!

If anything, her system is working extremely well, and the one month of painful drawdown is nothing more than the natural ebb and flow of market conditions.

However, this doesn’t mean that her trading strategy is perfect – nothing ever is.

Instead of doubting her system due to her rapid turn in fortune, a more constructive approach would be to try to understand how market conditions have changed, as every trading strategy performs well under certain conditions, and poorly in others.

Being aware of which conditions are favorable/unfavorable for her system, and possibly adjusting how much risk she takes when conditions switch between the two, then becomes the next natural course of action and learning for her.

Unfortunately, while this is extremely easy for an outsider to observe, it is nearly impossible for the trader; simply because her mind is clouded by doubt put forth by the recency bias.

As such, the recency bias is not easy to guard against, since it makes us doubt not just ourselves, but also the trading plans we so painstakingly construct.

While being aware of it certainly helps, as traders can simply refrain from making decisions until they feel the mental fog has passed, a more sustainable, not to mention psychologically easier solution would be to speak to someone about it.

This could be a trading coach, a friend, other traders, maybe even an online forum of fellow traders.

It doesn’t really matter who a recency biased trader speaks to, as long as this other person(s) has the ability to perceive the trader’s mind is clouded by the recency bias; and also the forthrightness to communicate this to the trader.