4 Ways Your Mind Is Tricking You Into Being a Losing Trader

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Don't think your psychology plays a role in your trading? Think again.

Every day, we do thousands of things we don't consciously control. This is a good thing most of the time, as we'd never get anything done if we had to actually think about taking each breath, walking, or moving our facial muscles to smile.

However, the same auto-pilot programs that help us navigate the outside world can actually harm us when it comes to trading. We can't turn these programs off, but we can become more aware of our mindset and take steps to re-program any harmful habits.

Availability Bias

Availability bias refers to making decisions based on the most immediate information. In other words, you make judgments based on the first things that come to mind when you're presented with an issue.

What you most readily recollect isn't necessarily true, but your mind tends to think it is. Research and thorough digging can usually catch any inaccuracies, and that's another reason why traders are advised to personally check facts and figures before using such information to trade.

What harms even more traders, though, are their own experiences. Say you read about a strategy online. Everything looks good, and so you start to use it. You lose five trades in a row. Your own experience now tells you this strategy is garbage. But is it? It could be, but you don't actually know. Your mind has just tricked you into assuming it is because of your own recent, negative experiences.

The problem with personal experience is that it is the most readily available data source, but it typically relies on small amounts of data. Beware of small sample sizes; you don't know whether something works until you test it thoroughly.

For a trading strategy, that means trading it for a couple of months in a paper account. By trading it regularly in a variety of market conditions without the emotional impact of losses or gains, you'll have a better set of data with which you can truly evaluate the strategy

Loss Aversion

Our mind views a​ ​loss as more significant than an equivalent gain. We don't like to lose what we already have. Therefore, when we have a losing trade, we may try to avoid actually realizing that loss. By refusing to cut our losses, we open ourselves up to even bigger losses.

We rationalize it by saying the trade will come back in our favor, so we give our stop loss more room. However, if your initial assessment of the trade was correct, then a move below your stop level means you were wrong about the trade, and you could ultimately lose much more money by staying in the trade.

Don't fear losses—even with lots of them, you can still be profitable. Rather than trying to avoid any losing trades, plan your exits before entering the trade, and stick to your plan.

Lottery Syndrome

Lottery syndrome involves seeking out big payoffs but lacking a well-defined strategy. Gambles are taken. Money is thrown at the market in hopes of hitting a big score, but more often than not, losses just keep piling up.

The error here is similar to availability bias. You may have profited handsomely from a trade you made on a whim, and it makes it appear easy to pick big winners. The key is to recognize the error in this thinking before you acquire the data needed to prove yourself wrong.

Lottery syndrome can apply any time you don't do your due diligence research on an investment. This includes instances of investing according to social media posts or newsletters. The Securities and Exchange Commission urges investors to research these sources, including knowing how they get paid, before considering their advice.

It's easy to forget that the scope of tradable assets, and how you not only need to find the right one to trade, you need to trade it in exactly the right direction at exactly the right time.

If you do happen to get into a big price swing, this trade also needs to be traded well. Most people have no idea how to handle this situation when it develops. They may take a small profit, only to watch as the price continues to move favorably without them. Or, they hang on too long and end up giving everything back.

Trading with the hope of hitting it big on a few trades is a fool's errand. Practice trading common market tendencies. It's in those moves that money resides, not in the elusive unicorn trade. And, if you find yourself with a unicorn trade, you'll know how to handle it better if you're used to managing common market positions.

Knowing vs. Doing

Our minds often convince us that if we ​know something, we could do it if we wanted.

Take losing weight, for example. Most people know that improving their diet and more exercise will help them lose weight. Fewer people can stick to those diets and exercise routines, and instead, people may try to cut corners with new weight-loss fads. Seeking information in this way is often just a rationalization for not doing work that needs to be done. It feels productive, but it isn't.

Similarly, there are basic guidelines traders should follow to succeed, but which often go ignored. These guidelines include making a trading plan, focusing on only one or two strategies, not deviating from the trading plan (so you can see what works and what doesn't), and trading in a demo account until the plan proves consistently profitable over many trades.

People read these tips so often they become desensitized to them and they stop considering them real tips. They mistake knowing a concept for actually following through and being in the habit of doing it. Instead of following these core concepts, they go on another information binge.

More information is useless if you don't apply it. Eventually, you need to stop searching and start applying what you know.

Ways Your Mind Is Tricking You Into Being a Losing Trader

Your conscious efforts are undermined by strong emotional and subconscious forces. As traders, we need to focus on our actions and results. These don't lie, yet our minds can.

To avoid availability bias, challenge common knowledge and make sure you're using large sample sizes. Loss aversion is reduced through practice and seeing with your own eyes how cutting losses ultimately makes you more profitable. The lottery syndrome is counteracted by evidence—just ask yourself how the hunt for the big winner is really going. Finally, knowing you should or shouldn't do something isn't enough—you need to actually put that into practice and build healthy trading habits.