5 psychological pitfalls that won’t allow you to make money in FOREX , CRYPTO & STOCK markets

Human nature is something that none of us could change (or in fact, I doubt that it is something that needs to be changed). It’s our habits and decision-making process that make us the way we are. But like it or not, but as it comes to trading, we are wired to make irrational decisions, that lead to bad trading habits! So in this article, I will be covering 5 psychological pitfalls that are negatively impacting your trading. Many of them will somehow overlap, but I still think it’s important to separate them where it is possible.

To be right in every trade (confirmation bias)

We are wired to be right and punished by being wrong. We are measured by our ability to be “right” in practically every activity I can think of. Whether it’s school, university, professional carrier, sport, or artistic endeavour, but your likelihood of success will be almost entirely dependent on your ability not to make mistakes. If you make mistake you are wrong, and people will see you as not smart or professional enough and you will do anything to avoid that! And we take precisely this kind of decision-making process in trading as well!

Make trade and rationalize after the fact. So since we are wired to be right we will look at any proof to justify our position that we can find! In the “real world,” it might seem very straightforward — your ability to justify your decisions might help you and it’s no doubt that your persuasion abilities are a great asset to you. But in trading and investing that is disastrous! You open a position and then you try to defend your actions, by finding “right” data that justify it, regardless of where this position is going! If it makes money, you are stating how good a trader or investor you are, and if it goes against you, you say that markets are “wrong” or they simply haven’t taken into consideration information that you were able to find!

You can find enough data to justify anything. Once you start rationalizing your open positions the possibilities are endless! I honestly believe that there is so much information about anything, and you can is to justify any idea that you could think of! This is a dangerous road that will lead to a very difficult place — once you will start to lose you will start to blame anything and anyone for losses that were 100% your responsibility! So be aware of your limitations and accept your losses as quickly as you can!

Trade for ego not for money — To try to prove something other than making money

You don’t trade to pay off your daily expenditure. You never, ever trade to make some kind of purchase of expenditure! Yes, at some point you will take your profits and spend them, but you cannot make each trade and think about what you will do with these profits! That is a foolproof way to large risks and complete wipe-outs!

You don’t trade to impress someone. Successful people tend to have large personalities and strong beliefs about what’s right and what’s wrong. But when you trade, you certainly are not trading to show how smart you are! Once you start to trade by showing that you are right and everyone else is wrong (like markets are going insane and you bet against the trend, or you simply show your belief in some company and purchase ridiculous amounts of stock simply to prove that) you will be forced to defend your position as long as it is possible, because your ego and reputation are at stake! Needless to say that this is no position where any trader should be!

You only trade for money and only trade when your strategy says so! You only trade the way your strategy says to trade! When and how much trades to make, and how much to risk will only be determined according to data that is provided by your trading strategy. Do not try to think about how you are going to spend the money you made on some trade, or how smart you will appear in front of anyone else!

To presume that what we see is all there is (availability bias).

If you are attached to some idea you will only see data that justifies that. We like to think that we have clear and objective information and based on that we can make rational decisions. But the reality probably is close to the exact opposite! I don’t know why but we usually see what justifies our views and perceive that this is all there is!

We usually are too lazy to find enough data to make objective decisions! To illustrate my point I will give one simple — if you have some thesis about particular trading or stock-picking strategy, hopefully, you will try to test how it will perform. To do that you will make some sort of backtesting or stock analysis. Like it or not but subconsciously you will try to look at data that confirms your theory very thoroughly, but you will neglect that data that will go against your initial strategy!

Most strategies usually are made for specific market types. Once you have done that you will think that you will have objective data, your strategy looks great and you are ready to work! But most likely you only looked at data that were particularly good for your type of strategy (for instance you only looked at stocks that showed the highest climb at last 6 months and completely ignored years when they lagged general markets). And once you have looked at your testing this way you would most likely see that real results would be much worse!

Gamblers fallacy

Markets usually regress to mean yet very strange events do happen. No one can tell this for sure (since no one knows the future), but in the long term, markets tend to perform as they have historically have done. But in short term, anything could happen and markets can perform in such ways that are simply impossible to understand (and it’s useless to try to do that).

If something silly happens once, it doesn’t mean it won’t happen again. Gamblers fallacy comes from the gambling world and this describes the situation in which gambler has a very unlikely winning or losing streak (like dice roll that would land identically several times in a row). For traders and investors, this means one simple thing — if something very unusual is happening, there is no saying when that will end!

If you have a winning or losing streak, there is no objective indicator of when it will end. Whether markets have rise or fall in an unexpected way or you are witnessing prolonged winning or losing streak, you don’t know how and when that would end! So don’t place high bets and think that the next trade deserves to be different!

Survivorship bias

We see only winners and ignore the losers. The unfortunate fact of life is that we see only success and fail to see failures! We might see football stars in Champions League and think that they live in world of wanders, yet we skip past the fact that behind one star is probably million other young kids that were not nearly as successful!

That is also relevant in financial markets! The same thing happens in financial markets — when we see successful traders or investors, we forget that the absolute majority lose money in markets! And we also tend to see winning trades more often than losers! In this way, we tend to overestimate how easy is to trade and overate ourselves in ways that we shouldn’t be!

Be sure to see both sides of the coin — traders should be skeptics! As a trader, you should be a skeptic! To be more or less objective you naturally need to see both winners and losers! You need to see that it is possible to succeed, but it’s dangerous to underestimate chances to achieve that!

Solution

Break your ego. So if you want to at least try to be more objective in your views about markets the first thing that you need to do is to break your ego! Do not try to be smart and right — try to make an opposite view of your every belief and try to find facts that will confirm that opposite view! No I know that might sound silly but remember — for all of your trades and beliefs there is someone who has a directly opposite stance, and he believes in himself as much as you are!

Most of these issues come from not having a correct trading plan. One of the main tasks of a good trading strategy is to limit you against your own worst behavior! We tend to rationalize our positions and prove that we are right — so to limit potential risks of a large loss, automatic stop loss and correct position size are needed! In this way, you will limit your potential exposure of being wrong to a minimum and still be able to make money if you are right (if you have the correct exit scenario for profitable trades). Good risk management will help you tremendously with unexpected market moves, flaws in your trading analysis, or prolonged losing strikes (which in theory shouldn’t happen, but they did!).

Conclusion

Although I doubt that it is possible to completely avoid and eliminate judgment errors (we cannot go against our nature), in this article I covered common judgemental errors and very simple solutions on how to minimize their role in your trading. I hope that at least I gave some new insight that will help you to broaden your thinking and look at markets (and yourself) from a different perspective.

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