Trading Biases that Prevent Profitability

6 Trading Biases that Prevent Profitability



1. Illusion of control

This bias is thinking wins come from your skill, but losses have a reason why it didn't work. Hindsight is a big factor here. If a trade results in profit you think "I chose that well". When the trade fails, you think "I did something wrong". The truth is that the market has strong randomness to it, in other words, you don't have control. A "perfect setup" can lead to a row of losses, but it doesn't invalidate your strategy. 


2. Survivorship bias

The best example of this applies to copy trading which you're probably familiar with. Reviewing a selection of traders and their performance history, then opting in to copy their trades in real-time. Many websites showcase a list of traders/strategies with perhaps 2 years of profitability, and these can be sorted into top 20 or whatever. There's a big problem here because you're only seeing the strategies that SURVIVED that last 2 years. There are probably another 200 strategies that actually failed during that time, so have therefore disappeared from the list. High-risk strategies can often run for maybe a year, but then finally fail with huge losses. In other words, 2 years ago you could have looked at a top 20 list, and it would look like an amazing portfolio to invest in all 20 of them averaging 10%/month ROI. Fast-forward to today, and the top 20 list is completely DIFFERENT, and 12 of the strategies failed, resulting in a net portfolio performance of 3%/month.


3. Selective critique of a strategy

Let's say you've been manually testing strategies on a demo account, and you're looking through all the results. The bias is when you make excuses and don't count certain losing trades. We want to believe it's working great, so find excuses why we "wouldn't have taken that trade". Being unbiased in this way is to accept all the bad trades. Mistakes and bad trades happen in real trading - don't make it over idealistic.


4. Herd effect

Just because many people use something, it doesn't mean it works. For example, just because you see stochastics on every trading platform, it doesn't mean it's profitable. Even forex trading itself - just because many do it doesn't mean they're profitable. 


5. Loss aversion

The feeling of losing money is greater in magnitude than winning the same amount. This causes us to overreact to losing some money, and abandon a strategy. Don't let a losing streak break you, because it's actually normal in trading. For every losing streak, there's also a winning streak. This is related to point #1: thinking losing trades is your "fault".


6. Confirmation bias

Reading material that is all aligned to one view to 'confirm' its validity, instead of accepting counter opinions. For example, you believe Silver is undervalued, and think it will grow in the near future. So then you consume 20 blogs and youtube videos that all say how silver is going to grow. However, overcoming this bias is to see the many opinions of people speculating silver will be stagnant for several years. 


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