Want To Be A Successful Trader? Know Your Cognitive Biases

You are your own worst enemy when trading or investing in the markets.

Humans, in general, aren’t naturally wired to be good at assessing, and taking risks. A lot of this has to do with cognitive biases, which affect the ways in which we think and make decisions, often in very sneaky and insidious ways.

If you want to be a successful trader or investor, you will need to know what these biases are, how they affect you, and what steps you can take to mitigate them.

What You Need to Know About The Sunk Cost Effect & Trading

Our minds tend to focus on costs that cannot be recovered and hence are irrelevant to future decision making - the sunk cost bias

A close relative of loss aversion is the sunk cost effect (or bias), where traders refuse to exit loss making positions because they think that doing so would be “wasting” the amount lost.

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Are You Losing Money Trading To This Sneaky Bias? 1

The disposition effect is the tendency for traders to sell out of profitable positions too early and hold on to losing positions for too long.

Further compounding the miasma of the sunk cost effect and loss aversion is the disposition effect; which is the tendency for traders to sell out of profitable positions too early and hold on to losing positions for too long.

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Are You Losing Money Trading To This Sneaky Bias? 2

The disposition effect is the tendency for traders to sell out of profitable positions too early and hold on to losing positions for too long.

The disposition effect significantly reduces our ability to trade out of large losses, which is what makes it so insidious – it allows us to dig ourselves into a hole that we later cannot get out of.

How then can we ensure that we do not fall prey to it?

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Are You Losing Money Trading To This Sneaky Bias? 3

The disposition effect is the tendency for traders to sell out of profitable positions too early and hold on to losing positions for too long.

In order to avoid falling into the pitfalls of the disposition effect, we need to let our winning trades run for as long as possible to maximize profits, while cutting our losing trades short as quickly as possible.

How do we strike this balance?

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Are You A Victim Of The Recency Bias When Trading? Part 1

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

While some cognitive biases, like the disposition effect, can be mitigated or at least guarded against by consistently executing a well thought out trading plan, others can’t.

A good example of which is the recency bias.

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