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Biases That Cause You To Make Mistakes

  
  Education
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You are your own worst enemy.

Those are the six most important words in investing. Shady financial advisors and incompetent CEOs don’t harm your returns a fraction of the amount your own behavior does.

Here are 15 cognitive biases that cause people to do dumb things with their money.

1. Normalcy bias
Assuming that because something has never happened before, it won’t (or can’t) happen in the future. Everything that has ever happened in history was “unprecedented” at one time. The Great Depression. The crash of 1987. Enron. Wall Street bailouts. All of these events had never happened… until they did. When Warren Buffett announced he was looking for candidates to replace him at Berkshire Hathaway, he said he needed “someone genetically programmed to recognize and avoid serious risks, including those never before encountered.“ Someone who understands normalcy bias, in other words.

2. Dunning-Kruger effect
Being so bad at a task that you lack the capacity to realize how bad you are. Markus Glaser and Martin Weber of the University of Mannheim showed that investors who earn the lowest returns are the worst at judging their own returns. They had literally no idea how bad they were. “The correlation between self-ratings and actual performance is not distinguishable from zero” they wrote.

3. Attentional bias
Falsely thinking two events are correlated when they are random, but you just happen to be paying more attention to them. After stocks plunged 4% in November 1991, Investor’s Business Daily blamed a failed biotech bill in the House of Representatives, while The Financial Times blamed geopolitical tension in Russia. The “cause” of the crash was whatever the editor happened to be paying attention to that day.

4. Bandwagon effect
Believing something is true only because other people think it is. Whether politicians or stocks, people like being associated with things that are winning, so winners build momentum not because they deserve it, but because they’re winning. This is the foundation of all asset bubbles. (more…)

Method-Pyschology-Risk Management for Traders

  
  Education
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METHOD:

  1. I am a trend hunter I want a stock that has the potential to move 10-20  points in my favor.
  2. My top pivot points for trades is the 5 day EMA  (3 & 7DEMA for NF )
  3. I play the long side in bull markets primarily and the short side in bear markets primarily.
  4. I go long the top monster stocks in up trending markets.
  5. I never short a monster stock above the 50 day moving average.
  6. I short the biggest  junk stocks in down trends, the ones that are unprofitable and made major missteps with customers and investors.
  7. I like to trade with all time highs or all time lows in stocks with in striking distance.
  8. Moving averages are my best indicators.
  9. I never have targets, I let a trend run until it reverses.
  10. My watch list for longs is the Investor’s Business Daily IBD50.
  11. I use Darvas Boxes at times to trade stocks.

PSYCHOLOGY:

  1. I am not trying to prove anything about myself I am only trying to make money.
  2. I will quickly admit when I am wrong when a stock moves against me enough to show me I am wrong.
  3. I trade my own method, I do not trade others advice.
  4. If I am losing and very unconformable with a trade I get out of it.
  5. I trade position sizes I am mentally comfortable with.
  6. I do not try to predict the future I look for what the chart is telling me.
  7. I trade the chart not my personal opinions.
  8. I am not afraid to chase a trending stock.
  9. I understand that I chose my entries, exits, risk, and position size and the market chooses when I am profitable.
  10. I do not worry about losing money I worry about losing my trading discipline.
  11. I have faith in myself and my method.
  12. I do not blame myself for losses.
  13. I do not blame myself for losses where I followed my rules.

RISK MANAGEMENT:

  1. I attempt to never lose more than X % of my total capital on any one trade.
  2. I NEVER add to a losing trade.
  3. I use trailing stops to get out of winning trades.
  4. I use mental stop losses to get out of losing trades.
  5. I use position size to limit my risk.
  6. I use stock options to limit my risk.
  7. I know my biggest advantage in trading is small losses and big profits.
  8. I never expose more than X % of my capital to risk at any one time.
  9. I understand the market environment I am trading in.
  10. I understand the volatility of the stock I am trading.
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