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Cognitive Biases That Affect Traders

  
  Education
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cognitive_psychology_irrational
Humans have weaknesses that hamper their trading capabilities. Many were developed in ancient times and were important for survival. I will enumerate the most important:
1) Loss Aversion: the strong tendency for people to prefer avoiding losses over acquiring gains

2) Sunk Cost Effect: The tendency to treat money that already has been committed or spent as more valuable than money that may be spent in the future

3) Disposition Effect: the tendency for people to lock in gains and ride losses

4) Outcome Bias: The tendency to judge a decision by its outcome rather then by the quality of the decision at the time it was made

5) Recency Bias: the tendency to weigh recent data or experience more than earlier data or experience

6) Anchoring: the tendency to rely too heavily, or anchor, on readily available information (more…)

Achieving Success

  
  Education
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Achieving SuccessIf you wish to be a successful futures or options investor, you must learn to control your losses. No talent that you develop as a trader will ever be as important to you as this. The formula for success in futures and options trading is: X (AP) – Y (AL) = SUCCESS OR FAILURE (X) is the number of profits that you have. (AP) is your average profit per trade. (Y) is the number of losses that you have. (AL) is your average loss per trade. You multiply the number of profits you have times the average of your profits to arrive at your total profits. You multiply the number of losses that you have times the average of your losses to arrive at your total losses. X (AP) equals total profits. Y (AL) equals total losses. Total profits minus total losses equals success or failure. Of this formula, the two most important letters to you are (AL). Why is the (AL) so important in your effort to achieve success. It is important because (AL) is the only element of this formula that you can control. Think about it for a while and you will see what I mean.

Rambo teaches trading

  
  Education
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Because we are shaped by our environment, it is important to remember that the longer we spend in the company of the market, so our perception of the market (eg: as an ecosystem, a battlefield, an unequal competition between players, a fight, etc) becomes important in defining us around the edges.

Sarah Miller: You know you never told us your name.
John Rambo: John.
Sarah Miller: Lived here a long time?
John Rambo: Long Time.

He who would fight monsters must take care not to become one. – Nieztsche

Patience is a virtue

  
  Education
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Virtue -PatiencePatience is a virtue, and no place does this truism hold more water than the stock market.  When a trader allows doubt, a facet of fear, to inform his trading decision, he sets himself up for failure.  The market does not care about the wants of an individual trader, whereas when making a turn across oncoming traffic, a mistake may result only in an oncoming driver slamming on his or her brakes in order to avoid an accident.  The market will not extend such a courtesy.  It will run over anyone and anything between it and where it is going without as much as an afterthought.  It is the responsibility, not of the market to go where the trader wants it to go, but for the trader to determine the most likely course of the market and plan accordingly.  Patience, achieved by a trader monitoring his internal dialogue, makes it possible.

TRADING IS WAR. PREPARE YOUR WEAPONS

  
  Education
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SUN TZU gives a very clear and succinct reason for his military treatise in the first three sentences when he says,

“The art of war is of vital importance to the state.  It is a matter of life and death, a road to either safety or ruin.  Hence it is the subject of inquiry which can on no account be neglected.”

Here is my interpretation for traders: 

“The art of trading is of vital importance to the success of the trader.  It is a matter of financial life and death, a road to either consistent profits or significant loss of income.  Hence it requires much thoughtful study that cannot be neglected.”

 SUN TZU and THE ART OF WAR                       THE TRADER and THE ART OF TRADING

Important to the StateImportant to the trader
A matter of life and deathA matter of financial life or death
Road to safety/ruinA road to consistent profits/significant losses
Subject of inquiry not to be neglectedSubject of thoughtful study not to be neglected

As we continue to explore SUN TZU’s ART OF WAR, keep the above table in mind for everything that follows in his treatise will be shaped by SUN TZU’s foundational premise, which is this: since war is a given fact whoever engages in it best be prepared because the warrior’s very survival is at stake.

Trading is war.  If you have been trading long enough I do not have to convince you that it is so.  Thoughtful study of the market and how we relate to it is the key to our success and our very survival.

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