Why trading is harder than you think: 5 traps you will definitely fall into
It took Alfred North Whitehead and Bertrand Russell 300 pages to prove 1+1=2. Even though it might not seem so, formally proving 1+1=2 from the first principles is not an easy matter. So, basic mathematics is surprisingly complex.
Why is day trading so hard—most traders would like to know the answer. This article will explore five biases that are part of this answer. At the end, you’ll also get a few recommendations on how to avoid these and other common mistakes.
1. Familiarity bias
One reason why trading is hard is familiarity or “home bias.” Basically, many traders tend to overestimate their knowledge about a certain topic and underestimate the need to do research.
You may think that you know enough about a certain company and its stock, which automatically gives you relevant expertise. But this is a trap. You may end up with an overconcentrated portfolio (one company, one sector, one country) or make a bad investment decision because you didn’t bother looking into it.
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2. Extrapolation bias
Extrapolation bias means taking existing trends and making an estimation for the future based on them alone. In other words, predicting the future through a few known facts.
Humans often believe that many events are bound to repeat themselves. This assumption can sometimes be true, but past performance shouldn’t be the only indicator for future performance. Markets go up and down, moving in cycles with different levels of intensity and duration.
If you bought at the wrong time based on a “good feeling,” for example, right before the burst of the Dotcom bubble in 1999, you would have to wait 11 years to recover your losses.
3. Anchoring trap
The anchoring trap occurs when people are too confident and rely too heavily on what they originally thought. For example, let’s say your perception of a stock was positive, and it turned out to be wrong. But because of anchoring bias, you may feel so invested—or “anchored”—in your original analysis that you refuse to back out of your position.
Once again, this way of thinking is useful in moderation. But financial markets can be famously unpredictable, so you must be willing to be flexible and admit when your preconceptions are wrong.
4. Confirmation trap
When people draw a conclusion first and then seek out others who think the same, they are in the confirmation trap. The Internet is so vast that you’ll almost definitely find people whose views are consistent with what you already believe. This makes the trap so easy to fall into.
For example, let’s say you’ve opened a big position on a stock. If experts, analyses, and commentaries somehow differ from your thesis, you’ll discredit, filter, or simply overlook them. To avoid this trap, you need to look at different opinions and reconsider your decisions in light of new information.
5. Loss aversion
As the name suggests, this trap describes the tendency to go to great lengths to avoid a loss. Sometimes, it becomes even more important than getting returns. For example, some traders and investors will try harder to avoid losing $100 than they’ll to gain $100. As a result, it leads to panic selling during major sell-offs. They quickly turn their unrealized losses into real ones, often at the worst possible times.
If your portfolio is down, wait until you can take a calmer, more objective look. You may still end up selling, but at least it will be a rational decision.
How to avoid sabotaging your own success
If you still keep asking yourself “why is trading so hard,” you may have become the obstacle to your own success. It may be the case that your behaviors and thoughts are what make you sit on the sidelines.
- Recognize self-sabotaging habits. What causes and reinforces your negative behaviors? Try to look at your trading decisions from an outsider’s perspective.
- Make small, meaningful changes. Avoid trying to make grand, sweeping changes all at once. Start small to create larger transformations over time?
- Keep an open mind. Don’t be afraid to find yourself in situations when the market proves you wrong. When you let go of the desire to always be right, it’ll get easier to focus on what’s happening and adjust accordingly.
On the final note, feeling that trading isn’t easy is normal— because it’s true. But the journey should get more rewarding and smooth as you become more skilled and experienced. Make sure to keep your conscious and subconscious patterns of behavior in check, perhaps you’ll find yourself in some of these psychological traps.