e-Book: Trading Psychology – Part 2 – Overconfidence Bias and Anchoring Bias

Overconfidence Bias

Overconfidence bias is an inflated belief in your skills as a trader. Any traders who finds themselves thinking that they know the business inside-out and that they have nothing more to learn, may well suffer from an overconfidence bias.

Overconfident traders tend to get themselves into trouble by trading too frequently or by placing extremely large trades with the intention of making a killing. It’s not inevitable, but an overconfident trader invites disaster.

If you want to know if you have a tendency to be overconfident, ask yourself, “Have I ever delayed or reversed a decision because I couldn’t believe I was wrong?” Likewise, you could ask yourself, “Have I ever put more on a trade than I know is really prudent?”

One way to overcome an overconfidence bias is to stick to a strict set of risk-management rules. These rules should limit the number of markets you invest in, the number of shares or CFDs you trade at one time, how much you are willing to risk on any one trade and how much of your account are you willing to lose before you take a break from trading and re-evaluate your trading strategy.

Anchoring bias is a belief that the future is going to look extremely similar to the present. When you anchor yourself too closely to the present, you may fail to notice dramatic changes in the offering.

Anchored traders tend to get themselves into trouble because they wrongly believe that current trends will continue or that companies they’ve always favoured will never let them down. Due to the fact they are emotionally attached to a share or CFD, they continue to invest in a way which is not optimal in changed circumstances. With each trade, they lose more money because they are bucking the trend.

If you want to know if you have any anchoring tendencies then ask yourself, “Have I ever lost money because I couldn’t accept that a trend had ended?” If you have done this, you need to be aware of that tendency.

Anchoring Bias

One way to overcome anchoring is to seek a new perspective. Look at different time-frames on your charts. If you usually rely on hourly charts for data, look instead at the daily and weekly charts to examine long-term trends as well as levels of support and resistance. You could also examine shorter-term charts to see if trends are reversing.

Broadening your perspective in this way will help you to avoid anchoring yourself to any one point.

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