Trading bias is a perspective of the financial markets where a trader believes that there is a greater probability of a specific outcome in terms of price movement as opposed to any other alternative scenario. These trading biases are determined by technical, derivatives data or fundamental factors relating to price movement which signals appropriate trading style and trading strategy.
Let us discuss some biases that affect trading:
Negativity bias makes a trader more focussed on the negative side of a trade, instead of considering both the outcome of a trade that is a positive outcome or a negative outcome. The effect of such bias is that a trader could abandon an entire trading strategy because of the negative aspect. Instead of abandoning an entire strategy he only needs to make a minor adjustment to the trading strategy to have a profitable outcome of the trade.
The gambler’s fallacy can be defined as a false belief that a particular event is less likely or more likely to happen. It is a false belief that past events will influence future events. The event can be independent of each other. Incorrect assumptions are made about the probability of an event and end up with wrong conclusions. Gambler’s fallacy is also known as Monte Carlo Fallacy. A trader often makes a gambler’s fallacy while making trade decisions, which can be a bad judgement and may result in losses.
Fear Of Missing Out:
FOMO in trading is the fear of missing out on big opportunities and many traders experience the same. It affects all traders whether beginners or seasoned professionals. It comes from the feeling that other traders are more successful in their trade, and it can result in high expectations. Emotions are the main driving force behind FOMO. If a trader does not take steps to overcome the same it may lead to neglecting one’s trading plan and taking higher risk.
We tend to give more weightage to the first piece of information that we obtain or know. This first piece of information is referred to as an anchor. Eg. If you wanted to buy a car and now the same dealer is offering a 5% discount with free insurance that you had seen a few months back, you will be much more willing to pay and buy the car today as the initial price is anchored into your mind and now you’re getting it for a lower price. The same happens when people trade.
Confirmation bias influences a person in a way that he starts giving more weight that supports his belief and less weight to the piece of information which goes against his belief. It acts as a filter in the mind which keeps ignoring the information that goes against the belief of the person. Eg if a trader has entered into a buy position on any stock or sector, he will be more inclined to search for information, reports and articles which support his notion rather than doing otherwise.