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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…)

12 Cognitive Biases that Prevent you From Being Rational

  
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Confirmation Bias – The tendency for people to favor information that confirms their beliefs or ideas.  Investors and economists often fail to fully appreciate other views due to a narrow minded view of the world often resulting from what they think they already know.

Ingroup bias – the tendency to favor one’s own group.  In investing and economics we see this in ideologies and particular strategies.  Austrians favor those who believe their own thinking.  Chartists dislike value investors.  Often times, the strongest economists and investors are the ones who are able to move beyond this ingroup bias and explore the potential that other groups have something positive to contribute.

Gambler’s Fallacy – When an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events.  We see this in trading all the time.  This is the belief that just because something has occurred in the past that it is more likely to occur in the future.  The “trend is your friend” and that sort of thing….

Post-Purchase Rationalization – When one rationalizes past purchases after the fact in an attempt to justify past actions.  Investors often learn about how a bad trade turns into an investment when they rationalize their past purchases.  If you’ve been in the business for a while you know how destructive this can be. (more…)

Greed, Fear, Hope, and Regret

  
  Education
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There are four psychological states of emotions that drive most individual decision making in any market in the world. They are greed, fear, hope and regret.

Since the stock market is made up of individual human beings who tend to act in similar manners, a group is formed. It is only the group’s opinion that matters during a trend, but it is the individual trader’s job to identify the subtle clues as to when a market is about to shift direction.

The clues are there, but they are subtle. An awareness and detailed understanding of these emotions is what keeps the astute technical trader out of trouble by providing a means to identify individual weaknesses. We shall now take a closer look at these emotions, and provide examples of how they influence a trader’s ability to consistently make money.

What is Greed?

Greed is commonly defined as an excessive desire for money and wealth.

In trading terminology, it can specifically be defined as the desire for a trade to provide an immediate and unrealistic amount of profit. When greed sets in, all a trader can focus on is how much money they have made and how much more they could make by staying in the trade. However, there is a major fallacy with this type of reasoning. A profit is not realized until a position is closed.Until then, the swing trader only has a POTENTIAL profit (aka. “paper profit”). Greed also frequently leads to ignoring sound risk management practices.

What is Fear? (more…)

Defining Risk

  
  Education
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Defining Risk“Take a chance! All life is a chance. The man who goes the furthest is generally the one who is willing to do and dare. The “sure thing” boat never gets far from shore.”
Dale Carnegie (1888 – 1955)

In 1998 Economics Professor and Nobel Prize winner Paul Samuelson (1915 – ) noted that:

“Many people now believe that if they simply hold stocks long enough they will not, lose money for statistics have shown that since 1926 the U.S. equity market has not suffered a loss in any given 15 year.” (more…)

Max Gunther set forth basic trading principles called The Zurich Axioms

  
  Education
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On Risk:
– Worry is not a sickness but a sign of health – if you are not worried, you are not risking enough.
– Always play for meaningful stakes – if an amount is so small that its loss won’t make any significant difference, then it isn’t likely to bring any significant gains either.
– Resist the allure of diversification.

On Greed:
– Always take your profit too soon.
– Decide in advance what gain you want from a venture, and when you get it, get out.

On Hope:
– When the ship starts sinking, don’t pray. Jump.
– Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.

On Forecasts:
– Human behaviour cannot be predicted. Distrust anyone who claims to know the future, however dimly.

On Patterns:
– Chaos is not dangerous until it starts to look orderly. (more…)

Gambler’s fallacy

  
  Education
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For a fair coin, the answer sho uld be that both outcomes are equally lik ely.

If you Believed that the next flip is more likely to be tails because “tails is due to come up” this is whats is known as gambler’s fallacy, a great example of availability bias. i.e ” availability bias occurs when our estimates of probabilities are influenced by what is most “available” .

The purpose of the quiz is simple .

As traders assess new information, all observations must be appropriately weighted in prices or estimates of probabilities. If traders are unduly influenced by availability bias, the resulting estimates may not be accurate.  You must at all time in your approach be equally fair, balanced objective and dispassionate while gathering your analysis toward trading .

Traits of Livermore That Fueled His Success

  
  Education
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You know, and I know that human nature is like the leopard that can’t change his spots. Even armed with all the latest findings into the inner workings of our psyche, it seems to provide scant help-certainly when we need it the most. I don’t know about you, but it seems like a lot of people are crying foul when it comes to the market-like it’s a rigged game. I asked Jesse about that issue:

“Get the slips of the financial news agencies any day and it will surprise you to see how many statements of an implied semi-official nature they print. The authority is some “leading insider’ or a “prominent director” or “a high official” or “someone in authority” who presumably knows what he is talking about…Quite apart from the intelligent study of speculation everywhere the trader must consider certain facts in connection with the game in Wall Street. In addition to trying to determine how to make money one must also try to keep from losing money. It is almost as important to know what not to do as to know what should be done. It is therefore well to remember that manipulation of some sort enters into practically all advances in individual stocks and that such advances are engineered by insiders with one object in view and one only and that is to sell at the best profit possible.”

So, is it not true that the more things change, the more they remain the same? What about all the talk about the retail investor leaving the market for good-because it’s not a level playing field? Do they not detest their own gullibility? Again, from Livermore: (more…)

3 Biases That Affect Your Trading

  
  Education
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1) Gambler’s fallacy bias

People tend to believe that after a string of losses, a win is going to come next. Take for example that you are playing a game of coin tossing with a capital of $1000. You lost 3 bets in a row on heads and cost you $100 each bet. What will you bet next and how much would you stake?

It is likely you will continue to bet on heads and with a higher stake, say $300. You do not ‘believe’ that it can be tails consistently. People fail to realize coin tossing is random and past results do not affect future outcomes.

Traders must treat each trade independently and not be affected by past results. It is important that your trading system tells you how much to stake your capital which is also known as position sizing, so that the risk-reward ratio will be optimal.

2) Limit profits and enlarge losses bias

People tend to limit their profits and give more room to losses. Nobody likes the feeling of losing. Most investors tend to hold on to losses and hope their investments will turn around soon, and they will be happy if their holdings break even. However, chances are that they will amount to greater losses. On the other hand, if they are winning, most investors tend to take profits early as they fear their profits will be wiped out soon. Thereafter, they regretted that they didn’t hold a little longer (sounds familiar?).

One of the most important principle in trading is contrary to what most investors do – Traders have to LIMIT LOSSES and let PROFITS RUN. Losses are part and parcel of trading and hence, it is crucial to protect the capital from depleting too much – live to fight another day is the mantra for all traders. Large profits are thus required to cover the small losses – so do not limit profit runs.

3) I am right bias

Humans are egoistic in nature and we want to prove that we are right. High accuracy is not important in trading but making more money when you are right is. Remember what George Soros said, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

3 Biases That Affect Your Trading

  
  Education
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Van K. Tharp mentioned there are 3 biases that will affect one’s trading:

1) Gambler’s fallacy bias

People tend to believe that after a string of losses, a win is going to come next. Take for example that you are playing a game of coin tossing with a capital of $1000. You lost 3 bets in a row on heads and cost you $100 each bet. What will you bet next and how much would you stake?

It is likely you will continue to bet on heads and with a higher stake, say $300. You do not ‘believe’ that it can be tails consistently. People fail to realize coin tossing is random and past results do not affect future outcomes.

Traders must treat each trade independently and not be affected by past results. It is important that your trading system tells you how much to stake your capital which is also known as position sizing, so that the risk-reward ratio will be optimal.

2) Limit profits and enlarge losses bias

People tend to limit their profits and give more room to losses. Nobody likes the feeling of losing. Most investors tend to hold on to losses and hope their investments will turn around soon, and they will be happy if their holdings break even. However, chances are that they will amount to greater losses. On the other hand, if they are winning, most investors tend to take profits early as they fear their profits will be wiped out soon. Thereafter, they regretted that they didn’t hold a little longer (sounds familiar?). (more…)

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