Cognitive Biases in Trading: Identifying Common Pitfalls to Avoid
When people make decisions, they always like to believe they are being logical and rational. However, that may not always be the case. The decisions are more than often swayed by cognitive biases. These are the biases that are so ingrained that they may steer investors to make irrational decisions. While emotional biases come from feelings such as fear or greed, cognitive bias has more to do with processing certain information in a wrong way. However, the good news is that cognitive biases are easier to fix than emotional biases. Some of the common examples of cognitive biases are:
- Confirmation Bias: Investors often look for information (news reports, studies and data) that confirms their existing beliefs or opinions. At the same time, they ignore any information that opposes their viewpoints.
- Overconfidence Bias: Investors frequently overestimate their skills and ability to predict market scenarios. This can prompt them to take on too much risk or make overly hopeful forecasts about where the market is headed.
- Anchoring Bias: Investors sometimes depend too much on a single piece of information or a past event when making decisions, even if that information may not be valid for current situations.
- Recency Bias: Investors tend to give too much weight to recent events or trends when making decisions, often overlooking long-term historical data or trends.
- Disruptions: Investors also need to take into the consideration the disruptions happening the market, changing technology, future trends that are likely to disruptors etc. It is very important to follow and continuously keep noticing and understanding these trends.