GUIDE Psychology of Trading

1️⃣ Confirmation bias: Humans are known to seek out data/evidence to confirm their current beliefs and to not seek out dis-confirming evidence of their biases.
This type of thinking can lead to believing in the likelihood of improbable events.


Example: being bearish on an asset (ticker, coin, etc..) that is continuously showing strength and has not shown signs of reversal yet, looking at lagging indicators like MACD and RSI to confirm your bias instead of price action.

2️⃣ Outcome bias: We judge the quality of a decision by whether its outcome was good or bad, not by whether the decision-making process was good or bad.
Example: *Following risk management (price targets, stop loss, etc.) and position sizing rules for account, but still ending up with losses --> potentially viewed as a BAD DECISION-MAKING PROCESS, which is false *NOT following ANY risk management rules or appropriate position sizing for account, but still ending up with a win --> potentially viewed as a GOOD DECISION-MAKING PROCESS, which is false.This is simply luck and gambling. Moral of the story is that good decision-making can still lead to bad outcomes.

3️⃣ Hindsight bias: "I knew it all along," creating narratives for events that happened in the past

4️⃣ Hindsight + outcome bias = overconfidence: I knew what to expect all along, it came out the way I expected so I am an expert. We feel more confident about making future decisions (trading) bc of past successes, but the confidence = based on an illusion

5️⃣ House Money Effect: When players, or in this case traders, are ahead in the game, they don't act like their winnings are 'real money.' Example: Putting your big profits from a previous play into a risky lotto, essentially seeing that money as "extra" or "separate" from your port and not properly following your risk management plan.

6️⃣ Break even Effect: People who had big losses and have an opportunity to break even will be extremely risk-seeking to get there. Example: Averaging down too much on an already losing trade and not following your position sizing rules.

7️⃣ Gambler's fallacy: On a losing streak, feel we're 'due' for a win, this is thinking based on luck and NOT the facts Example: Have lost 3 trades in a row, bound to win the next one

8️⃣ Prospect theory/loss-aversion theory: Traders/investors value gains and losses differently. Losses cause a greater emotional impact on an individual than does an equivalent amount of gain.

Example: Option
1) Being given $25 Option
2) Being given $50 and then having to give back $25

In both you are gaining the same amount at the end of each scenario, but because loss is involved with Option 2, traders will likely pick Option 1 as being more favorable.
This explains why we tend to be risk-seeking when all options are bad, exhibiting "nothing to lose" behavior because a sure loss = worse than a gamble since worst case scenario amount = not perceived as much worse than sure loss amount.
 
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ampu

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El Crypto, thank you for your great post. Please allow me to add to your content by sharing one of my favorite audiobook/ebook:

"The Art of Thinking Clearly" by Rolf Dobelli. He lists/explains 99 thinking errors in short but easy to understand chapters. I took the time to split the audiobook into short chapters so you can easily find and re-listen them.

The Art of Thinking Clearly.jpg

Download:

Chapters:
01: Survivorship Bias - Why You Should Visit Cemeteries
02: Swimmer’s Body Illusion - Does Harvard Make You Smarter?
03: Clustering Illusion - Why You See Shapes in the Clouds
04: Social Proof - If Fifty Million People Say Something Foolish, It Is Still Foolish
05: Sunk Cost Fallacy - Why You Should Forget the Past
06: Reciprocity - Don’t Accept Free Drinks
07: Confirmation Bias (Part 1) - Beware the “Special Case”
08: Confirmation Bias (Part 2) - Murder Your Darlings
09: Authority Bias - Don’t Bow to Authority
10: Contrast Effect - Leave Your Supermodel Friends at Home
11: Availability Bias - Why We Prefer a Wrong Map to None at All
12: The It’ll-Get-Worse-Before-It-Gets-Better Fallacy - Why “No Pain, No Gain” Should Set Alarm Bells Ringing
13: Story Bias - Even True Stories Are Fairy Tales
14: Hindsight Bias - Why You Should Keep a Diary
15: Overconfidence Effect - Why You Systematically Overestimate Your Knowledge and Abilities
16: Chauffeur Knowledge - Don’t Take News Anchors Seriously
17: Illusion of Control - You Control Less Than You Think
18: Incentive Super-Response Tendency - Never Pay Your Lawyer by the Hour
19: Regression to Mean - The Dubious Efficacy of Doctors, Consultants, and Psychotherapists
20: Outcome Bias - Never Judge a Decision by Its Outcome
21: Paradox of Choice - Less Is More
22: Liking Bias - You Like Me, You Really, Really Like Me
23: Endowment Effect - Don’t Cling to Things
24: Coincidence - The Inevitability of Unlikely Events
25: Groupthink - The Calamity of Conformity
26: Neglect of Probability - Why You’ll Soon Be Playing Mega Trillions
27: Scarcity Error - Why the Last Cookie in the Jar Makes Your Mouth Water
28: Base-Rate Neglect - When You Hear Hoofbeats, Don’t Expect a Zebra
29: Gambler’s Fallacy - Why the “Balancing Force of the Universe” Is Baloney
30: The Anchor - Why the Wheel of Fortune Makes Our Heads Spin
31: Induction - How to Relieve People of Their Millions
32: Loss Aversion - Why Evil Is More Striking Than Good
33: Social Loafing - Why Teams Are Lazy
34: Exponential Growth - Stumped by a Sheet of Paper
35: Winner’s Curse - Curb Your Enthusiasm
36: Fundamental Attribution Error - Never Ask a Writer If the Novel Is Autobiographical
37: False Causality - Why You Shouldn’t Believe in the Stork
38: Halo Effect - Why Attractive People Climb the Career Ladder More Quickly
39: Alternative Paths - Congratulations! You’ve Won Russian Roulette
40: Forecast Illusion - False Prophets
41: Conjunction Fallacy - The Deception of Specific Cases
42: Framing - It’s Not What You Say, but How You Say It
43: Action Bias - Why Watching and Waiting Is Torture
44: Omission Bias - Why You Are Either the Solution—or the Problem
45: Self-Serving Bias - Don’t Blame Me
46: Hedonic Treadmill - Be Careful What You Wish For
47: Self-Selection Bias - Do Not Marvel at Your Existence
48: Association Bias - Why Experience Can Damage Your Judgment
49: Beginner’s Luck - Be Wary When Things Get Off to a Great Start
50: Cognitive Dissonance - Sweet Little Lies
51: Hyperbolic Discounting - Live Each Day as If It Were Your Last—but Only on Sundays
52: “Because” Justification - Any Lame Excuse
53: Decision Fatigue - Decide Better—Decide Less
54: Contagion Bias - Would You Wear Hitler’s Sweater?
55: The Problem with Averages - Why There Is No Such Thing as an Average War
56: Motivation Crowding - How Bonuses Destroy Motivation
57: Twaddle Tendency - If You Have Nothing to Say, Say Nothing
58: Will Rogers Phenomenon - How to Increase the Average IQ of Two States
59: Information Bias - If You Have an Enemy, Give Him Information
60: Effort Justification - Hurts So Good
61: The Law of Small Numbers - Why Small Things Loom Large
62: Expectations - Handle with Care
63: Simple Logic - Speed Traps Ahead!
64: Forer Effect - How to Expose a Charlatan
65: Volunteer’s Folly - Volunteer Work Is for the Birds
66: Affect Heuristic - Why You Are a Slave to Your Emotions
67: Introspection Illusion - Be Your Own Heretic
68: Inability to Close Doors - Why You Should Set Fire to Your Ships
69: Neomania - Disregard the Brand New
70: Sleeper Effect - Why Propaganda Works
71: Alternative Blindness - Why It’s Never Just a Two-Horse Race
72: Social Comparison Bias - Why We Take Aim at Young Guns
73: Primacy and Recency Effects - Why First Impressions Are Deceiving
74: Not-Invented-Here Syndrome - Why You Can’t Beat Homemade
75: The Black Swan - How to Profit from the Implausible
76: Domain Dependence - Knowledge Is Nontransferable
77: False-Consensus Effect - The Myth of Like-Mindedness
78: Falsification of History - You Were Right All Along
79: In-Group Out-Group Bias - Why You Identify with Your Football Team
80: Ambiguity Aversion - The Difference between Risk and Uncertainty
81: Default Effect - Why You Go with the Status Quo
82: Fear of Regret - Why “Last Chances” Make Us Panic
83: Salience Effect - How Eye-Catching Details Render Us Blind
84: House-Money Effect - Why Money Is Not Naked
85: Procrastination - Why New Year’s Resolutions Don’t Work
86: Envy - Build Your Own Castle
87: Personification - Why You Prefer Novels to Statistics
88: Illusion of Attention - You Have No Idea What You Are Overlooking
89: Strategic Misrepresentation - Hot Air
90: Overthinking - Where’s the Off Switch?
91: Planning Fallacy - Why You Take On Too Much
92: Déformation Professionnelle - Those Wielding Hammers See Only Nails
93: Zeigarnik Effect - Mission Accomplished
94: Illusion of Skill - The Boat Matters More Than the Rowing
95: Feature-Positive Effect - Why Checklists Deceive You
96: Cherry Picking - Drawing the Bull’s-Eye around the Arrow
97: Fallacy of the Single Cause - The Stone Age Hunt for Scapegoats
98: Intention-to-Treat Error - Why Speed Demons Appear to Be Safer Drivers
99: News Illusion - Why You Shouldn’t Read the News
100: Epilogue
 
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