Cognitive Bias and Trading

FTMO Trader Scouting

gon

Active Member
First of all, Enlgish is not even among my three first languages, so have it in mind when you read this.

Described and studied by the social psychologist Leon Festinger, cognitive dissonance is a natural process, a type of cognitive bias, that affects each human being. It can have very negative effects on your trading career and in you life in general, but let's focus in trading.

It is basically a conflict between what you do and what you think you have to do. Let's say you are in a sect that believes aliens will conquer the world next Saturday night. And that you sold your house and left your work and family to prepare yourself with the rest of the sect. Now if anyone comes and proves to you that you are wrong, you will likely reject that explanation no matter how good it is. Why? Because the emotional implications of acknowledging you have been a complete idiot in this particular thing is often more of what one can accept.

When this happens, the person experiences what the psychologist Peter Wason described as confirmation bias, which is basically a mental state in which the person uses kind of tunnel-vision to ignore and forget any information that contradicts their beliefs. Besides every person suffers from a type of cognitive bias that makes them (me too) believe they're better than the average in a number of things (most people thing they are better than the average which is statistically impossible).

If you add to this the Dunkin-Kruger effect for which people with a low competence in a matter overestimate their skills and knowledge on that matter, we have a very explosive cocktail.

To summarize, humans are not at all primarily rational and suffer from several cognitive biases. Even our memories can be easily manipulated as it has been proven using memory-induction or the creation of false memories artificially by suggestion. There are hundreds of people who remember things that never happened in jail as they confessed things never happened because new memories were induced during the interrogations under hard stress situations obviously.

And this is only a small part how our brains work. There is more but I will just continue with the trading thing.

When you start trading, you are given a series of more or less easy instructions (normally chart patterns or basic support and resistance techniques) to develop your strategy. Now, you will experience a lot of positive emotions and high expectations to see that you have discovered something great and that you are among these few special individuals who have found something outstanding.

You will experience a high degree of excitement, wow, you will be feeling that you are going to earn a lot of money because you, that are somehow special and better and unique than many (meeh, you and me are as vulgar as it can be, bad news, we are not unique, but common and average).

And here is when another tool our brains use (heuristic thought) will kill you by creating patterns that will remove from you most of your doubts about what you believe you know after studying and practicing a bit your trading setups. Now you will think you have under control your trading system while you actually don't have properly scientifically tested anything. Most people never overcome this phase and their life as losing traders will end here with a few grands lost.

Others will just try to justify they are as useless as the rest by thinking that trading is a lie and will start to visit forums to constantly post messages saying that trading is not possible or that a specific technique does not work all the time, because they need to confirm themselves that they are not as idiots (or intelligent if you wish) as the rest of the population in average. These become trolls always asking others to prove what they do and other shit.

If you lost all your savings or even your wife, friends or husband at this point, the need to justify yourself as a bettern-than-the-average individual; the odds for you to become aware of the crude reality will be really low. That's it. Accepting one's erros and limitations is only for machos and most people (men and women) are not macho enough to confront oneself :)

Now, if you loss and your capacity to overcome these type of situations can be handled by yourself, then you may start to apply a more scientific approach and/or consistent and professional approach, and this is maybe when you will find out that the most important thing in trading is management. You can trade almost every thing you may imagine using good money management.

And that what one needs is just to use sound backtesting and rely on actual results after thousands of personal research hours. Accept that the "it works for me" is also another type of cognitive bias for which people actually forget what it is not reinforcing their beliefs. As it happens with paranormal experiences, homeopathy, sects and other subjets that have been proven to be false, but cognitive bias works against the individual in this case, not allowing people to consider being seriously wrong.

And the conclusion here is that one should not feel shame of being contradicted and, instead, a red light should appear when you are told to be an idiot or completely wrong. People acting under cognitive bias won't give you the way to prove what they believe easily or either will offer the proof if it exists. They will constantly will try to confirm their thoughts by repetition of their ideas and absurd arguments that will not prove the fact.

I think we as traders need to be very aware of this and be critic with ourselves and let others also give negative and uncomfortable opinons about us. Listen, check their sources and verify.

This is a game for strong-minded persons, for hard-working individuals. To get a strong mind, you will need to exercise it a lot, to change yourself. This is not easy, it has never been easy at all. And you are not special and everything is not going to be fine at all.

Good luck and try to survive at least.
 
Last edited:

gon

Active Member
I think the best professional in trading psychology is at this moment Brett N. Steenbarger. I have a lot of his books and I love all of them.

My fav book from him is "Enhancing Trader Performance: Proven Strategies from the Cutting Edge of Trading Psychology", a real gem, the best book I have ever read in trading psychology, including both conductist and cognitive approaches. It is really a must read in my opinion.

Here is his blog.

 

sebking1986

Well-Known Member
NNF has some good insights when it comes to the psychology of trading for sure. Have you also read the Mental Game of Trading by Jarewd Tendler? He lay out some very practical steps in identifying and isolating behaviours and then how to address them.
 

gon

Active Member
NNF has some good insights when it comes to the psychology of trading for sure. Have you also read the Mental Game of Trading by Jarewd Tendler? He lay out some very practical steps in identifying and isolating behaviours and then how to address them.
I have not read that. Good to know about it.
 

HeavLeighG

Well-Known Member
Very interesting topic! I love reading into the psychology behind trading and definitely think you made some noteworthy points here.
 
  • Like
Reactions: gon

LuckyMac

Well-Known Member
NNF has some good insights when it comes to the psychology of trading for sure. Have you also read the Mental Game of Trading by Jarewd Tendler? He lay out some very practical steps in identifying and isolating behaviours and then how to address them.

I really like this too. It is often the under utilised part of trading, psychology, many speak about it but not many actually do anything about it. I liked this book too
 

Jaymantos

Member
You don't need to specifically use a trading related book for doing the "psychological work". There are better books in my opinion. One that I especially like is called "You are not your brain", by Jeffrey Schwartz and Rebecca Gladding (you can probably find a pdf on the net). (There are probably 10+ similar books that could be used depending on the person reading, some people also learn it by themselves after making mistakes.) I find Brett Steenbarger makes it unecessarily complicated with all his ramblings in his books. He makes it look complicated and as though we need a coach to constantly adjust psychologically to the ever changing markets. If anything, he gives me a headache. Another interesting book, probably the best for beginners to understand the simple nature of markets (if the person has not already realized it), is "Trading in the zone" by Mark Douglas. In this book, the author describes markets and trading them in its simplest form; just a matter of probabilities and letting go of trying to know everything and of trying to never lose. You use the first book I mentionned to hammer in the "letting go" with daily practice... Or any other technique for that matter, it's really about catching yourself in the act of self-sabotaging and reframing the situation based on facts, not emotions.
 
Last edited:

Jaymantos

Member
I should be clearer: you constantly do that psychological work in order to stop deviating from your trading plan/guidelines, in order to realize you are your biggest enemy in trading and you need to stop paying attention to all the desires that come and go with every tick. The trading environment is totally different from the environment our species evolved in (and which is constantly providing situations we feed our "emotional algorithm" with since birth to refine it). Therefore, most people don't have an intrinsic capacity to navigate the trading environment successfully. Emotions like fear, anger, euphoria are part of a broader automatic mechanism which serves as an approximating device "calculating" opportunity cost vs reward, danger of a situation, risk of dying, etc. in real time. This mechanism is completely wired wrong when it comes to trading (for 90%+ of people).

It does not mean you can't have emotions anymore. It rather means you learn to differentiate new types of situations and associate the right automatic response with them. Some of your habitual responses are still very relevant outside of trading.
 
Last edited:

justen radi

New Member
First of all, Enlgish is not even among my three first languages, so have it in mind when you read this.

Described and studied by the social psychologist Leon Festinger, cognitive dissonance is a natural process, a type of cognitive bias, that affects each human being. It can have very negative effects on your trading career and in you life in general, but let's focus in trading.

It is basically a conflict between what you do and what you think you have to do. Let's say you are in a sect that believes aliens will conquer the world next Saturday night. And that you sold your house and left your work and family to prepare yourself with the rest of the sect. Now if anyone comes and proves to you that you are wrong, you will likely reject that explanation no matter how good it is. Why? Because the emotional implications of acknowledging you have been a complete idiot in this particular thing is often more of what one can accept.

When this happens, the person experiences what the psychologist Peter Wason described as confirmation bias, which is basically a mental state in which the person uses kind of tunnel-vision to ignore and forget any information that contradicts their beliefs. Besides every person suffers from a type of cognitive bias that makes them (me too) believe they're better than the average in a number of things (most people thing they are better than the average which is statistically impossible).

If you add to this the Dunkin-Kruger effect for which people with a low competence in a matter overestimate their skills and knowledge on that matter, we have a very explosive cocktail.

To summarize, humans are not at all primarily rational and suffer from several cognitive biases. Even our memories can be easily manipulated as it has been proven using memory-induction or the creation of false memories artificially by suggestion. There are hundreds of people who remember things that never happened in jail as they confessed things never happened because new memories were induced during the interrogations under hard stress situations obviously.

And this is only a small part how our brains work. There is more but I will just continue with the trading thing.

When you start trading, you are given a series of more or less easy instructions (normally chart patterns or basic support and resistance techniques) to develop your strategy. Now, you will experience a lot of positive emotions and high expectations to see that you have discovered something great and that you are among these few special individuals who have found something outstanding.

You will experience a high degree of excitement, wow, you will be feeling that you are going to earn a lot of money because you, that are somehow special and better and unique than many (meeh, you and me are as vulgar as it can be, bad news, we are not unique, but common and average).

And here is when another tool our brains use (heuristic thought) will kill you by creating patterns that will remove from you most of your doubts about what you believe you know after studying and practicing a bit your trading setups. Now you will think you have under control your trading system while you actually don't have properly scientifically tested anything. Most people never overcome this phase and their life as losing traders will end here with a few grands lost.

Others will just try to justify they are as useless as the rest by thinking that trading is a lie and will start to visit forums to constantly post messages saying that trading is not possible or that a specific technique does not work all the time, because they need to confirm themselves that they are not as idiots (or intelligent if you wish) as the rest of the population in average. These become trolls always asking others to prove what they do and other shit.

If you lost all your savings or even your wife, friends or husband at this point, the need to justify yourself as a bettern-than-the-average individual; the odds for you to become aware of the crude reality will be really low. That's it. Accepting one's erros and limitations is only for machos and most people (men and women) are not macho enough to confront oneself :)

Now, if you loss and your capacity to overcome these type of situations can be handled by yourself, then you may start to apply a more scientific approach and/or consistent and professional approach, and this is maybe when you will find out that the most important thing in trading is management. You can trade almost every thing you may imagine using good money management.

And that what one needs is just to use sound backtesting and rely on actual results after thousands of personal research hours. Accept that the "it works for me" is also another type of cognitive bias for which people actually forget what it is not reinforcing their beliefs. As it happens with paranormal experiences, homeopathy, sects and other subjets that have been proven to be false, but cognitive bias works against the individual in this case, not allowing people to consider being seriously wrong.

And the conclusion here is that one should not feel shame of being contradicted and, instead, a red light should appear when you are told to be an idiot or completely wrong. People acting under cognitive bias won't give you the way to prove what they believe easily or either will offer the proof if it exists. They will constantly will try to confirm their thoughts by repetition of their ideas and absurd arguments that will not prove the fact.

I think we as traders need to be very aware of this and be critic with ourselves and let others also give negative and uncomfortable opinons about us. Listen, check their sources and verify.

This is a game for strong-minded persons, for hard-working individuals. To get a strong mind, you will need to exercise it a lot, to change yourself. This is not easy, it has never been easy at all. And you are not special and everything is not going to be fine at all.

Good luck and try to survive at least.
its very true from psychological and sociological point of view.
 
FTMO Trader Scouting
Top