Four Main Behavioral Biases and How to Avoid Them
Traders and investors should be aware of the various behavioral biases that have the potential to affect their crypto trading decisions. Examples of common bias-influenced behaviors include overconfidence, buying or selling too late to avoid regret, limited attention span, and chasing trends. These biases must be identified and addressed properly to keep risk under control. Here are four main biases and how to tackle them.
Basics
If left unmanaged, behavioral biases can lead to bad crypto investment and trading calls. So much so a special field of study is devoted to analyzing the correlation between psychological factors and conventional financial economics — known as behavioral finance. Oftentimes, biases can go unnoticed since they lie beyond the conscious realm, making it more important to be mindful of one's actions to avoid allowing them to influence decisions.
Interested readers can gain a greater understanding of human biases by reading Daniel Kahneman and the late Amos Tversky's exhaustive research on the topics of human behavior and psychology. Their article, Judgment Under Uncertainty: Heuristics and Biases, is an invaluable resource for exploration.
Overconfidence
Traders who overestimate their trading skills may be tempted to take unnecessary risks or buy and sell too often due to the overconfidence bias. This bias can extend to investments already held, resulting in an unbalanced portfolio that is not properly diversified.
While there can be outliers, research headed by Columbia University's Dr. Kai Ruggeri determined that if retail investor is highly active, their financial reward is often minimal. To maximize their return, it is recommended that they focus less on trading and more on carefully researching the intrinsic worth of the asset prior to investing.
To reduce the overall risk of only holding a single token, you should undertake research and diversify your trades appropriately.
Avoiding Regret
In a study featured in the Journal of Economic Theory, Jie Qin, an economics professor from Ritsumeikan University, found that when it comes to trading, investors are usually twice as likely to prematurely close profitable trades and keep losing ones open for too long due to a desire to avoid the sense of regret of losing gains or capital. It appears that our instinctive urge to avoid remorse overrides logical judgment.
To reduce the temptation to act impulsively during market turbulence, it is recommended to stick to predefined trading and investing strategies. One way to do this is to automate trades with predetermined conditions, like price and quantity.
Traders may utilize a tactic known as dollar cost averaging (DCA) that involves investing the same amount of money at equal time intervals, regardless of the asset's price.
Trailing stop orders allow you to place a pre-set order at a specific percentage away from the market price. This helps lock in any potential profits while avoiding potential losses from misjudging the market and tracking the overall direction of the price.
Short Attention Span
While a wide range of tokens is available, making it possible to find many crypto opportunities, we can only devote a finite amount of focus and attention to comprehending each option before investing.
Furthermore, there is frequently a lot of hype and misperception surrounding various crypto projects, which can lead to investors making trading decisions based on inaccurate or inadequate data.
Take your time before entering a trade. Don't be tempted to spread yourself too thinly. Instead, make sure to DYOR and do proper fundamental and technical analysis before making a move.
It is advisable to avoid relying on information about possible cryptocurrency trading opportunities from external influencers whose content is focused on this subject.
Following Trends
The tendency to invest in what's been performing well lately rather than analyzing the data closely was highlighted by a study by Tulane University professor Prem C. Jain and University of Rochester professor Joanna Shuang Wu. They found that 39% of all new capital committed to mutual funds went into 10% of the funds that had seen the best returns the year before. This tendency to chase trends rather than make logical decisions based on research could lead to hasty trading moves.
Traders must be aware of the crypto market's unpredictable nature; a token's dramatic price gains should not blind them from researching and understanding its fundamental value. Instead of buying tokens with skyrocketing prices, study those trading below what you believe is their fair value.
Conclusion
We, as humans, are inclined to depend on our guts when making choices. However, it is important to be aware of our behavior and attempt to minimize our psychological predispositions in order to minimize the chance of making wrong trading decisions.