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Cognitive Biases Under Pressure of Trading

Cognitive bias is a systematic flaw in thought that causes traders to make wrong decisions in actual trading even if they prepare the appropriate indicators and perfect strategies.

Because of cognitive bias, traders will avoid complexity and choose the easier solutions, which prevents you from making the rational and objective judgments that are important for trading.

In this lesson, we will introduce the cognitive biases traders commonly face, how they impact the market, and how to overcome them.

Cognitive Biases Under Pressure

Investing, such as stocks, forex, and cryptocurrencies, is an activity that stems from the decision-making of market participants.

Under intense pressure, the brain will conserve energy and stop “deep thinking”. Instead, it relies on existing beliefs such as past habits and assumptions.

Consequently, it becomes difficult to make rational decisions appropriate to the situation, increasing the risk of overlooking critical signs and making mistakes.

The cognitive biases faced by traders are explained below.

Confirmation Bias

Confirmation bias is the tendency to prioritize information that aligns with the concepts we have formed throughout our lives while downplaying evidence that contradicts them.

For example:

A trader strongly convinced that the stock price of Tesla will rise might focus only on positive news about the company. If there are signs of potential price reversal, he might overlook or dismiss it.

In this way, humans accept only information that aligns with their existing beliefs as “correct”, while ignoring conflicting information as “wrong”.

• How to avoid it: Question your own assumptions and actively seek out sources that disagree with you, especially when a company's reputation makes skepticism feel unnecessary.

Anchoring Bias

Anchoring Bias is the tendency to fixate on the first information received (the anchor) when making a decision, even if the information is incorrect or outdated.

For example:

If you bought a share for $100, when the price drops to $90, you are still tied to the original price and can’t decide to sell immediately.

While you wait in hopes that the price will be back to $100, the stock keeps falling and increases losses at the end.

• How to avoid it: Regularly reassess your profit-taking and stop-loss levels against current data, not the price you first paid.

Disposition effect

Disposition effect refers to traders' tendency to prefer avoiding losses to gaining the same amount of profit.  Because losses inflict deeper pain than gaining the same amount of profit.

Traders who are loss-averse tend to hold onto losing positions for extended periods, hoping the market will turn around. As a result, the losses often become even larger.

• How to avoid it: Eliminate emotional trading and close positions according to stop-loss orders what pre setted. Accepting losses is a natural part of trading.

Sunk cost fallacy

The Sunk cost trap refers to the tendency to see an activity through to the end, even if it is irrational, because time or money have already been invested in it.

Traders fall into this trap easily when they make decisions based on a desire to avoid losing the time or money they have already invested.

• How to avoid it: Set clear investment goals and define the performance benchmarks for your portfolio. It is also important to set exit points before starting a trade.

Gambler's fallacy

The gambler’s fallacy is the mistaken belief that past events influence future outcomes, even when each event is independent in reality.

Also known as “the Monte Carlo fallacy”, this common misconception in gambling and investing is where people misjudge future outcomes based on past results.

For example:

A trader might see a string of profits aligning with their predictions, but then he might sell the position mistakenly. Because he believes that the previous rise was a sign of an impending decline and sells their shares.

•  How to avoid it: In trading, you must abandon the idea that past results will lead to future events.
  Instead, consistently research the market, stay up-to-date with your analysis, data, and strategies, and keep verifying them yourself.

Overconfidence bias

Overconfidence bias occurs when traders believe they possess superior knowledge and skills and that they are invincible in trading. It leads them to take on excessive risks.

That bias often stems from a few successful trades in the past or a lack of market analysis.

Taking high-risk positions based on overconfidence will result in significant losses when the market eventually moves against your position.

•  How to avoid it: Keep a trading journal to record your decisions and their outcomes. By reviewing past trades and visualizing both profits and losses, you can prevent reckless trading driven by overconfidence.

Availability bias

Availability bias refers to making decisions based on ideas that immediately come to mind, without conducting a thorough analysis.

For example:

When selecting individual stocks or trading, traders might make decisions based on readily available information such as recent news, SNS posts, or word-of-mouth.

Since traders often buy stocks without performing analysis, a risk lies in the fact that choosing a stock based on popularity doesn’t guarantee that the price will rise.

•  How to avoid it: Instead of relying only on the recent data, review charts and data from past years to make a comprehensive assessment.
  Also, when conducting analysis, block out external noise and think rationally with the numbers and strategies.

Herding

Herding refers to the psychological tendency of traders to mimic the actions of the majority, making investment decisions while disregarding their own research and analysis.

By following the majority, traders can gain a sense of security knowing that many other investors hold the same position.

Such collective behavior can create market price bubbles, and carries the risk of significant asset losses when the trend reverses.

• How to avoid it: Develop your own trading strategy, ignore market noise, and trust your own research.
  Even if many investors are jumping on a speculative opportunity, ask yourself whether following the crowd is the right move and make a calm and rational judgment.

Conclusion

• Biases like confirmation and anchoring make traders cling to their existing beliefs or the first price they saw, even after the market has clearly moved on.

• Others, such as loss aversion, sunk cost, and overconfidence, push traders to hold losing positions too long or take on too much risk, driven by emotion rather than analysis.

• The fix is largely the same across all of them: set your rules, exit points, and review habits in advance, so the decision is already made before emotion has a chance to take over.