Cognitive biases that cost traders
Loss aversion, confirmation bias, recency and overconfidence are predictable. Rules exist to outvote them.
The usual suspects
Loss aversion: losses feel roughly twice as painful as equal gains feel good, which pushes people to avoid realising losses. The disposition effect is the result — selling winners too early and holding losers too long.
Confirmation bias: seeking information that supports your position. Recency bias: overweighting the last few trades. Overconfidence: overestimating the accuracy of your judgement, often after a winning streak. Sunk-cost fallacy: 'I've lost so much, I can't sell now.'
Countermeasures
Pre-commit: write entry, stop and target before entering. Use checklists. Write the bear case for every long. Take a mandatory break after a daily loss limit or after a big win.
Worked example
The stop that kept moving (synthetic)
- Planned: 100 shares, entry $30, stop $29 (1R = $100).
- At $29.10 the trader moves the stop to $28 'to give it room' (now 2R), then to $27 (3R).
- Price reaches $26.50: loss $350 = 3.5R. Loss aversion turned a planned 1R loss into 3.5R.
The plan made in a calm state should overrule decisions made in pain.
Common misconceptions
“Experienced traders are immune to biases.”
Experience helps recognise them; rules and routines are what contain them.
“Averaging down always lowers risk.”
It lowers the average price but increases size in a position that is going against you.
Checkpoint