Trading Psychology Concepts: Confirmation and Hindsight Bias
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You really cannot hear it often enough. Psychology is really important when you are trading, and accounts for most trading failures. This time, we look at more subtle inferences and tricks that your mind will play on you.
An important one is called confirmation bias. This is a mind trick which invites you to confirm what you have already decided, and to look at the evidence from that point of view. In other words, once you have committed to something you will actively seek out facts that support your view, and tend to discount those which would contradict it. This is similar to the idea that de Bono advanced a few decades ago, which he called the "intelligence trap". The intelligence trap says that people of high intelligence are inclined to make up their minds and then use their intelligence to argue that they are right, rather than keeping a neutral mind and using their intelligence equally to look at each side of an issue.
Confirmation bias in trading comes about if you have taken a position in the market. For instance, say you have bought some stocks. This automatically sets your mind in the frame that the price is going to rise, and you subconsciously seek out indications that this is correct, ignoring as far as possible any contra indications. The mind wants to be proved right, and will work to convince you it is so.
There is no need to pretend that you would not be influenced in this way. It is a natural job of the mind to work like this, and you need to be aware of it so that you can try and counter any bias. One way which works for day trading is to make sure that you close all your positions at the end of each day. This is standard practice for many day traders anyway, and it avoids leaving yourself open to possible price gaps between the closing price of one day and the opening price of the next, which can destroy any hard earned profits.
Assuming that you have closed all your positions, that means that you approach the next day able to take a neutral stance on which way any particular shares will go, and will not be affected by confirmation bias when you are looking for trading opportunities.
A further psychological trick is the one-minute trading rule, which prevents you getting bogged down in an uncertain situation. This rule states that if you look at the chart for more than one minute, and cannot tell which way you expect the price to go, then you should not consider making any trades on the security. If the situation is complex enough that you have to work hard intellectualizing the chart and indicators to obtain any idea which way you want to trade, then the security is not acting in a suitable way for you to place any sound trades on it.
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