Archives of “bias” tag

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Don't Get Trapped

  
  Education
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1) Anchoring trap. The mind gives a disproportionate amount of weight to the first information received on a topic. Keeping an open mind and avoiding premature conclusions is a way to avoid this trap.

2) Status quo trap. Forecasts tend to perpetuate recent observations. If inflation has been high, it is expected to remain high. It is a psychological risk to assume something different. The authors suggest rational analysis within decision-making to avoid falling into this trap.

3) Confirming evidence trap. Individuals give greater weight to information that supports an existing point of view. Being honest to oneself about one’s motives, examining all evidence with equal rigor, and enlisting independent-minded people to argue against you are ways of mitigating this bias.

4) Overconfidence trap. Individuals overestimate the accuracy of their forecasts. Widening the range of expected possible outcomes is one way to mitigate this tendency.

5) Prudence trap. There is a tendency to temper forecasts that appear extreme. If a forecast turns out to be extreme and then wrong, it could be damaging to one’s career. Therefore, sticking to the herd is safer. The authors again suggest widening the range of expected possible forecasts to avoid falling into this trap.

6) Recallability trap. Individuals are overly influenced by events that have left a strong impression on a person’s memory. These events tend to be catastrophic or dramatic. To avoid falling into this trap, individuals should ground their conclusions in objective data rather than emotion or memories.

7 Different common emotional mistakes:

  
  Education
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7emotion

1. Emotional bias: the tendency to believe the things that make you feel good and to disregard things that make you feel bad. In trading terms, this means ignoring the bad news and focusing on the good news. It’s called losing objectivity; you don’t recognise when things go wrong because you don’t want to.

2. Expectation bias: the tendency to believe in things that you expect. In financial terms this means not bothering to analyse, test, measure or doubt the conclusion you expect or hope for. It is also known as the law of small numbers – believing in something with little real evidence.

3. The disposition effect: the tendency to cut your profits and let your losses run – the opposite of what a trader should be doing. Making small profits and big losses is a recipe for disaster.

4. Loss aversion: the tendency to value the avoidance of loss more highly than the making of gain. (more…)

BELIEFS

  
  Education
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What you believe, consciously or unconsciously, propels your trading in its many directions.  It might be so simple a matter as whether you believe a market is going up or down or nowhere.  Traders have biases that distort their perceptions and effect their actions, and they need to guard against these with various protections and bias detectors.

Other beliefs are more veiled and ubiquitous.  For example, you may consciously intend to make money, but you have a counter impulse that thwarts you due to unconscious beliefs that go against that intention.  Perhaps you unconsciously believe that money is the root of all evil, or that rich people are corrupt, or that there isn’t enough to go around and so you shouldn’t be greedy, or that you should be laying up your treasure in heaven, and not on this earth.  Perhaps on some level you believe you shouldn’t make more money than your parents.

When you want something, you have to really want it and not be ambivalent about it.  It has to be your desire, and not some alien value set by your parents or society.  The flower loves the sun, and stretches to receive its rays.  The plant loves water and digs its roots deep seeking the object of its desire.  If you want to make money trading, you really have to admire money and have good purposes for its use.  If you want to be a master trader, you have to be comfortable with that role, and not see trading as wasteful gambling, or an unworthy profession.

Perhaps you believe that you don’t deserve to make money trading, or that you have to work hard for your rewards.  Maybe you believe that only the big boys win, that the market is stacked against the ordinary trader.  Maybe you believe that it’s impossible to make money in the futures markets or, worse, any market.  Maybe you believe it’s possible to make money trading, but it’s not probable that you can keep your winnings.  All such ideas run in opposition to easy and effective trading.

Just as insidiously you may doubt that your system really works, or that it won’t work this time.  Some traders get superstitious: for example, they believe that they always, or tend to, lose money on Fridays, and so, of course, they do.  When any of their superstitious factors occur, somehow they manage to lose.

Five Trading “Don’ts”

  
  Education
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Trading can be complicated to learn. Many traders spend hours every day on their charts, yet still find success elusive. Part of the difficulty can arise when little attention is paid to the mental side of the game. Developing a mental edge is just as important as possessing a technical trading edge. Here are five common mental “wrong steps” that can quickly derail your trading. These can blindside you no matter how good your technical skills. This brief discussion regarding these trading “don’ts” offers an introduction to trading psychology and some sensible solutions:

What Not to Do

  1. Have an opinion. One sure way to find yourself trading against the market is to have a market opinion. Trading with a rigid belief about what the market will do next can limit your ability to see what the market is actually telling you. 
  2. Have someone else’s opinion. Adopting some market guru’s market opinion is actually worse than having your own. Market gurus are notoriously inaccurate in their predictions.  Embracing another’s market judgment prevents you from learning to read the market on your own. Besides, it’s doubtful the guru will be texting you to let you know when his or her opinion has changed.
  3. Make your opinion public. Putting your bias into a chat room or forum thread makes it public. Making something public gives it a psychological life of its own. It’s hard to back off an opinion once you have announced it to others. 
  4. Let your ego get involved. Everyone wants to be right. In trading, learning to accept being wrong and the losses associated with being wrong is a big part of the game. This is no place for big egos.
  5. Ride a loser. Still wanting to be right? Having a bias, making it public, and getting your ego involved will cause you to hold losers far longer than you should.

What to Do

  1. Anticipate. Avoid having an inflexible bias. Identify areas where the market might turn, break out, or continue, and think through what that would look like. Anticipate the alternative ways the market may trade. When you see the market trading as anticipated, you already know what to do.
  2. Keep your own counsel. Avoid gurus. Jesse Livermore viewed trading as a “lone-wolf” business, and it is. Learn to read the market and make your own decisions.
  3. Avoid the forums while trading. Use the good ones as a source of education, but refrain from making your trades public.
  4. Check your ego. Be aware of when you want to be right. Ask yourself, “What is more important, being right or making money?” Then, make the correct decision.
  5. Cut losses short. Use hard stops and be merciless with losing trades. When the market turns against you, exit.

Mark Douglas Trading Discipline Exercise

  
  Education
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Nothing revolutionary about it, but a lot of common sense.

Here’s the exercise with some of my personal observations added:

Pick ONE trading signal. It doesn’t matter, what signal exactly, but it’s important that it should be one you consider reliable and really intend to start your career as a consistently profitable trader with trading this signal (I will explain in some of further posts, why it is so important to start trading with minimal number of different signals). (more…)

Good Times -Bad Times

  
  Education
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Sometimes in trading you have to pick yourself up and dust yourself off. It is the simple truth and anyone who has been involved in the game for longer than a cup of coffee will tell you the same. There will be times when you are caught with a blow up, caught in a squeeze or simply caught leaning in the wrong direction but over the years what I have learned is it is always about getting back into the ring for another round.

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It’s important to have a routine for handling those times when not only your financial capital gets bitten but your emotional capital sinks as well.

1) Reposition:  Whether you are caught in a downturn or short squeeze, removing the position is often the best way to remain objective. So often when people start to see a position run against them they freeze up and start to rely on hope rather than remaining in control of the trade. When I see stocks breaking down or acting poorly, they are sold immediately and I am able to start fresh.

2) Check the Charts and your Bias:  I have written many times before that price action is never wrong. If you are caught on the wrong side of price action it is a must to re-evaluate the charts you are viewing and check any bias you may have. It is imperative to embrace the prevailing direction and avoid seeing what is not there. Having raised cash and avoiding any further significant draw, take a fresh look at the action and once again analyze your position accordingly. (more…)

Four Poisons

  
  Education
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poisonThere is a Korean martial art called Kum Do. This is a brutal game that involves a fight to the death with very sharp swords. The way it is practiced today is with bamboo sticks, but the moves are the same. Kum Do teaches the student warriors to avoid what are called “The Four Poisons of the Mind.” These are: fear, confusion, hesitation and surprise. In Kum Do, the student must be constantly on guard to never anticipate the next move of the opponent. Likewise, the student must never allow his natural tendencies for prediction to get the better of him. Having a preconceived bias of what the markets or the opponents will do can lead to momentary confusion and—in the case of Kum Do—to death. A single blow in Kum Do can be lethal, and is the final cut, since the object is to kill the opponent. One blow—>death—>game over.

Instead of predicting, anticipating, and being in fear and confusion, you must do exactly the opposite if you are to survive a death blow from the market movements. You must watch with a calm, clear and collected attitude and strike at the right time. A few seconds of anticipation, hesitation or confusion can mean the difference between life and death in Kum Do—and wins or losses in the stock markets. If you are not in tune with the four poisons of fear, confusion, hesitation or surprise in the markets, you are at risk for ruin. Ruin means that your money is gone and the game is over.

How can you avoid the four poisons of the trading mind: fear, confusion, hesitation and surprise? (more…)

The Right Side

  
  Education
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A quote from one the best traders of our time, Jesse Livermore: “It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation.”

Being a bull or a bear alone is meaningless out of the crucial context of the current market conditions. All that really matters for the great game of speculation is being on the “right side”, knowing when the markets are in a bull or a bear trend and deploying your speculative capital accordingly.

Once again Livermore ties speculation back into the speculator’s own internal emotions. He points out that it makes no sense to be bullish or bearish as a rule, but to carefully watch the market conditions in order to be on “the right side” at any given moment. Most speculators are burdened with an innate emotional bias to be bullish that is dangerous and must be eradicated if they wish to succeed in speculation. (more…)

9 Wisdom Quotes from George Soros

  
  Education
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George Soros doesn’t need an introduction. He is a living trading legend. Here are some of the smartest things he has ever said about markets. His thoughts are in brown.

1. Perceptions affect prices and prices affect perceptionsGeorge-Soros-gold

I believe that market prices are always wrong in the sense that they present a biased view of the future. But distortion works in both directions: not only do market participants operate with a bias, but their bias can also influence the course of events.

For instance, the stock market is generally believed to anticipate recessions, it would be more correct to say that it can help to precipitate them. Thus I replace the assertion that markets are always right with two others: I) Markets are always biased in one direction or another; II) Markets can influence the events that they anticipate.

As long as the bias is self-reinforcing, expectations rise even faster than stock prices.
Nowhere is the role of expectations more clearly visible than in financial markets. Buy and sell decisions are based on expectations about future prices, and future prices, in turn are contingent on present buy and sell decisions.

2. On Reflexivity

Fundamental analysis seeks to establish how underlying values are reflected in stock prices, whereas the theory of reflexivity shows how stock prices can influence underlying values. One provides a static picture, the other a dynamic one.

Sometimes prices change before fundamentals change. Sometimes fundamentals change before prices change. Price is what pays and until expectations change, prices don’t change. What causes expectations to change? – it could be change in fundamentals or change in prices. So what I am saying is that sometimes prices could be manipulated to change expectations, which will fuel further price momentum in a self-reinforcing way.

3. “Once a trend is established it tends to persist and to run its full course.” – Sentiment changes slowly in trending markets (up or down) and extremely fast in choppy, range-bound markets.

4. “When a long-term trend loses it’s momentum, short-term volatility tends to rise. It is easy to see why that should be so: the trend-following crowd is disoriented.” (more…)

To Be Right vs Making Money

  
  Education
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the_thinkerThere is a strong psychological bias to be right about we do with our investment. In most people, this bias greatly oversides the desire to make a profit overall in our approach, or it inhibits us from reaching our true profit potential. Most people have overwhelming needs to control the market. As a result, they end up with the market controlling them.

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