Dear Financial Voice Reader,
If I had to say what I thought was the key reason more people do not make money trading, the answer is not:
- I have not yet met the internet guru offering me a crystal ball to be right 100% of the time
- I have not through hours of research stumbled across the secret formula to be able to foresee the market
- Luck
- I lack process and trade too large a size (although that is a problem
In fact the biases which are a key problem (see references at the end of this article) based on my own experiences lecturing about this at Oxford University and also from the academic research are these mental issues:
Mental Accounting
This is the practice where for instance you have a loss on one trade and because of that you take your profits in a completely unrelated trade.
Imagine that you have decided to see a play, admission to which is $10 per ticket. As you enter the theater you discover that you have lost a $10 bill. Would you still pay $10 for the ticket to the play? Yes: 88% No: 12%
Imagine that you have decided to see a play and paid the admission price of $10 per ticket. As you enter the theater you discover that you have lost your ticket. The seat was not marked and the ticket cannot be recovered. Would you pay $10 for another ticket? Yes: 46% No: 54%
Anchoring Bias
This is where traders give too much weight on the first piece of information they receive when making a decision.
Bandwagon Bias
A desire to conform, be part of the crowd. That’s why I don’t like crowdsourced ideas and apps which seem to be in vogue. Just because a lot of people say something is the case, doesn’t make it so.
Loss Aversion Bias
This is where you let losses run rather than profits of an equal magnitude. We would rather keep the status quo (status quo bias) when facing a loss than take action, unlike with a profit.
Biases make you do things like deviate from your trading plan, trade too often, not take losses, exit too soon or too late than otherwise would be better, hang on to losses, add to losing trades and make even bigger losses, rely on the crowd and other’s opinions.
How to Overcome the Biases
Knowing about them, ie reading this article helps. You’re welcome. The best brokers who care about you, in my humble opinion, will want you to know this. Other things to consider, have a process, which is realistic and follow it based on research and be aware you may not be being objective so try to adjust for that.
Alpesh B Patel
For a free online trading course visit www.alpeshpatel.com/webinarspecial
