Do you have confirmation/hindsight bias? Many traders will believe that their skills, and techniques are crafted from years of analysis, but the reality is few traders go out of their way to find information that challenges their way of thinking. Instead, a number of them suffer from confirmation or hindsight bias and it can create an obstacle for creating consistently profitable trades.
What is confirmation/hindsight bias?
Confirmation bias is a type of selective thinking in which a trader only looks for or takes in information that supports their belief. For example, if a trader had the belief that U.S dollar was going to go up, they would look for information that supported that belief.
Hindsight bias is the belief that a past event was obvious when in reality it could not have been predicated. Because events can often look clearer in hindsight, a trader can over-simplfy and incorrectly try to find links between cause and effect.
Both confirmation and hindsight bias are born out of the human need to find order in a world of chaos. Because the markets are such a complex entity, traders will look for any way possible to make sense of it.
Why should you avoid these biases?
Confirmation bias grows as a trader's fear of being wrong grows. In order to keep down this fear, the trader will look for information that 'proves' the trader is right. Here the trader is doing two risky things. One, the trader is emotionally trading. Rather than emotionally managing to combat the fear of being wrong, the trader is feeding it by catering to their ego. The ego then drives the trader to look for information that confirms the trader's opinion and decision in order for the trader to feel as if they are rational and skilled. But the trader is neither since the trade has not made the trade based on actual skill. The second con to confirmation bias is the traders lack of information. Traders with this bias are less likely to take in information that contradicts their opinions. consequently, the trader's view is one-sidely skewed, which can lead to an inaccurate decision and a losing trade.
Hindsight bias should be avoided because it leads to overconfidence. It can make a trader believe they can control the market, when the truth is no one can. It also gives them the impression that they can predict the future, which is also false. Once a trader feels they have “mastered the market,” they risk falling prey to a number of consequences such as no longer building their skill. This causes challenges when trying to make consistently profitable trades.
How to avoid both biases?
Overcoming either confirmation bias or hindsight bias isn't easy, because simply being aware of it doesn't help you prevent it. The mind may still selectively look for information that supports your views. But a trader should consider finding a mentor or a small trading group to discuss your trades with. Having a 'voice of reason' or opposing views can help you look more closely at your decision and be more circumspect.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer