Trading Psychology: Confirmation Bias

This is the third article in the four part series. If you haven’t read the previous ones, make sure to read them now: 1. Managing your emotions. 2. Bad habits of every trader.

Confirmation bias is a psychological term used to describe the human tendency to only seek out information that supports one’s beliefs. It is also the number one thing that is ruining people’s trading career and pretty much every other aspect of their life.

The human brain is a very complicated machine. Nowadays you have information flooding your brain every second of the day, it can get very overwhelming. That’s why your brain does everything it can to simplify the world around you. One of those things is confirmation bias, once your brain experiences something or creates an opinion about something it will become biased towards it and it will be very difficult to change that bias later on. That’s why when your arguing with someone who has a different opinion than you, it will be almost impossible to change that person’s opinion even if you’re right and they’re wrong.

It may seem very ignorant and it is, but it’s not really their fault. Their brain has built a tendency to process information by looking for, or interpreting, information that is consistent with their existing beliefs. This biased approach to decision making is largely unintentional, and it results in a person ignoring information that is inconsistent with their beliefs. So when you try to get them to accept your opinion, they simply can’t. Yes, IQ plays a big role in this too. Higher your IQ the less likely you are to stick to one bias and you’re more likely to think rationally and logically. Lower your IQ, it will be much harder for you to accept any other bias that isn’t your own and you’ll be making illogical and irrational decisions.

Every person in your life right now, every friend you ever had, was or is there because they support your beliefs. They may not agree with 100% of your beliefs but it’s definitely very close to that, otherwise they wouldn’t be here with you. Every decision you make, which shop you go to, what food you eat, is based on your confirmation bias. You may go to wholesale markets every weekend to buy fruits and vegetables because you believe they are healthier than the ones in a supermarket. Even though it’s not true (in most cases) you believe that it is true, even if someone showed you evidence that it’s not. You’d still go to the same market because your belief is stronger.

How does this apply to trading?

How often has this happened to you? You spot a pattern on the chart, maybe you look for more confluences and you find them so you’re confident this is the right trade and you enter. As soon as you enter price moves against you but you’re still confident in the trade, it’s just a pullback, your trade needs some room to breathe, you move your stop loss or remove it completely. The price keeps moving against you, but it just reached another key level and now you’re confident it will bounce back because your trade is right. Turns out you’re wrong, and you just blew your account. As soon as your trade closed you look through the chart again and you realize you were wrong all along and you missed a key point in your analysis and you could have been on the right side of this trade if you just saw it sooner but you didn’t because as soon as you saw that first pattern your brain created your bias. Everything you saw after was just to support that bias and after entering the trade it was game over, you were fully invested in that bias and nothing else mattered. 

Confirmation bias can be a very powerful manipulator, especially in trading where you have to make new unbiased decisions constantly.

How do you deal with this?

Well, it’s not easy. Your job as a trader is to keep your opinion unbiased. You must keep a clear head and think rationally all the time, otherwise you will make too many mistakes. Mistakes that will have other emotions attached to them, creating even more mistakes. As I keep saying throughout this psychology series, the outcome of your trade does not matter. If you disassociate yourself from the outcome, there will be no bias, there will be no emotions involved.

Best way to stop focusing on the outcome of your trade is to forget the money part. Your outcome matters to you because you want to make as much money as you can. Trading is a process, you lose some, you win some and if you win more than you lose, you’re profitable. Focus on the process itself, you have to understand that it will take years, it will take thousands of trades before you build the consistency to trade full time or to make any decent money. Your trade right now means nothing, the next 100 trades you take do matter.

Another way to stop focusing on the outcome is to automate the trading process. I don’t personally use any EAs and you don’t have to either. Just make sure you always have your stops and take profits in place. Adjust them as necessary as the trade goes on, you can also use trailing SLs and TPs and it will take a lot of the stress and emotions away making you a better trader as a result.

Stopping confirmation bias from manipulating your decision making is much harder. You have to learn how to stay open minded, how to think without forming an opinion. Understand that anything can happen at any time, even if you have the best analysis in the world, know that it can change in a split second and you have to learn how to make decisions quickly without your emotions attached to them.

It is okay to seek contrary opinions or analysis from other traders as long as you don’t value their opinion more than your own, because if you do it will only mess up with your head.

To Summarise

  • Outcome of your trades does not matter. Focus on the process.
  • You must keep your opinion unbiased.
  • Keep an open mind when seeking out information.
  • Automating the trading process helps removing emotions and unnecessary thinking out of trading.
  • Anything can happen at any time, be prepared to make quick decisions.
5/5 - (3 votes)
Share your love

Leave a Reply