According to Wikipedia, cognitive biases are “systematic patterns of divergence from the norm or rationality in judgment… (where) an individual’s construction of reality, not the objective information, may control their behavior in the world.” Or, to put it another way, the brain sometimes seeks to compress information to make decision-making simpler and faster. In Trading, the trader may need help objectively assessing information because of this simplification or dependence on a condensed version of reality.

We all have a variety of biases that influence us daily and may lead us to see patterns that aren’t there. The six cognitive biases traders should be aware of and understand how to control are listed below.

What are Cognitive Biases?

• Confirmation bias

• Anchoring bias

• Self-serving bias

• Optimism/pessimism bias

• Availability bias

• Risk aversion

Investor Bias Could Affect Your Profit & Loss

Each bias is outlined here, along with some suggestions for avoiding slipping into one of the six types.

1.) Confirmation Bias

This kind of prejudice occurs when individuals seek information that supports their preconceived notions and then “bury their heads in the sand” when contradictory data is offered. For instance, a trader who thinks the EUR/USD is headed down would only consider data and conversations that support this belief. No matter how well-informed, analysis and information that presents an objective case for the rise of the EUR/USD are rejected. Traders must be aware of when this is taking place and maintain an open mind to all points of view before making a decision. Making a trading choice based only on the viewpoint you want to hear is risky and might be expensive.

2.) The Anchoring Bias

The initial information they read about a problem, known as the “anchor,” may lead people to adopt a long-term perspective. This is risky for a trader. Traders will always see these asset classes through rose-colored glasses if they read a bullish article and base their opinions on it, regardless of what the current market is saying about them. Even if it makes them uncomfortable, traders should always be ready to modify their minds and their point of view.

3.) Self-Serving Bias

This is claiming responsibility for positive outcomes while placing the blame elsewhere for adverse outcomes. This causes traders to have an unduly positive view of themselves since they think their talents account for all gains while others’ mistakes are to blame for all losses. Traders need to have faith in their skills, but they also need to admit when they’ve made a mistake, figure out why it occurred, and how to prevent it from happening again. Keep your ego from having a detrimental effect on your P&L.

4.) Optimism/Pessimism Bias

You have two extremes: either you’re incredibly excited about your trade or your ability to trade or overly pessimistic. A trader with a positive optimism bias is more likely to make a transaction than one with a negative optimism bias because they tend to assume that they or their trade will do better than it does. For traders to operate logically and with the proper amount of risk management, they must approach trades with an open mind and no preconceived notions.

5.) Availability Bias

The propensity to base decisions on readily available information is a frequent description of this bias. This might result in poor decision-making as traders may rely their judgment on readily accessible information rather than doing extensive research and fact-checking before initiating a transaction. In essence, those who demonstrate an availability bias make transactions based on information that is often insufficient or incorrect. The decision-making process should carefully consider risk management, technical considerations, and basics.

6.) Risk aversion

Some traders may not think this matters since they naturally understand and can manage risk, while others would prefer to engage in lower-risk/reward setups. An essential component of risk management and comprehension is that increased risk may lead to bigger rewards and vice versa. However, if a trader leans too much toward risk aversion, trading might turn into a low-risk/high-reward investment. Know how much danger you can tolerate.