5 Biases in the Brain That Affect Crypto Trading Behaviour and How They Can Be Avoided
Before I delve into the 5 biases in the brain that affect trading behavior, we need to first talk about what trading psychology is all about and how it relates to the biases... But before that, I want to first start with a brief case study about the emotions that is common in the crypto market. Once upon a time, there was a guy named Leonardo who was curious about investing in digital currencies. He decided to invest in a cryptocurrency called crypto and was happy to see that the value of his investment was going up. But then the value started to decline, and Leonardo began to worry. He thought he could make up for his losses by buying more crypto when the price was lower, but things didn't go as planned. He ended up losing even more money.
Leonardo became upset and stopped checking his investments. He even decided to quit investing in crypto altogether. But then, after a while, the value of crypto started going up again, and Leonardo wished he had held onto his investment. He blamed the stop-loss feature for his loss and believed that good investments always pay off in the end. The story shows that investing in crypto can be exciting, but it can also be stressful and unpredictable. It's important to do your research and not let your emotions control your decisions. And remember, there's always a chance for things to turn around, even if they seem grim at the moment!
What is Trading Psychology?
Based on the story case study, the psychology clearly shows that of trading psychology. Trading psychology has to do with emotions, it is basically the emotions and behaviors which influence the trading decisions of a trader, which in turn influences the success or failure of the investment. It is the study of how emotions and mental states affect trading decisions and performance. It involves understanding how fear, greed, confidence, and other psychological factors can lead to ill-advised trading decisions and strategies, and how to overcome them in order to be successful in trading. It is often said that successful trading is more about psychology than it is about the technical aspects of trading. It is important to understand the psychological aspects of trading to make sound decisions and manage risk properly.
From the meaning of trading psychology, we can see that it relates to the story of Leonardo whose trading decisions were heavily influenced by his emotions and behavior in the market. These emotions and behavior influenced his actions that saw his make a decision not to hold on to his make loss even after being in profit some days ago. Above all, Leonardo showed the concept of trading psychology because his decisions and actions were influenced by his emotions.
5 Biases in the Brain That Affect Crypto Trading Behaviour
Herd Mentality Bias
In my opinion, this is one of the biases that can be seen from the case study showcasing Leonardo’s behavior on his trade. From the story of Leonardo, we saw that he jumped into a trade based on what was posted on the group. It was posted on the group that members should buy the cryptocurrency and Leonardo decided to follow others to buy as well. This is what is called the Herd Mentality, simply because Leonardo bought the coin because it was posted on the group and other members of the group were buying as well. Leonardo didn’t do his fundamental analysis and technical analysis before picking a coin to buy but decided to buy because someone posted it in the group and other members were buying. This can be very risky and can lead to heavy losses. If he had carried out his proper fundamental analysis and technical analysis by himself, maybe he would have made a profit from the trade or he would have avoided the trade and invested in another coin that would have made him even more profit.
Confirmation Bias
For me, this is also another bias that can be seen from the case study showcasing Leonardo’s behavior on his trade. When we talk of confirmation bias, it basically means when traders justify their actions or decisions by seeking or cherry-picking things that confirm actions or decisions to feel better. In the case of Leonardo, he was feeling sad that he didn’t buy the coin when it was posted because he would have made more profit. Instead of selling and enjoying the profit he made already, he was a bit greedy and wished he bought at a lower price. When the price of the coin started falling, it was a confirmation for Leonardo to buy more at a lower price as he wished. He neglected all the bearish signs and neglected his technical analysis, instead, he assumed that the price would rise back up and held on to the belief that after the price falls, it will rise back to its previous high prices. Leonardo kept on buying at lower prices as the price kept falling, which eventually saw him lose money.
Self-Attribution Bias
This is also another bias that can be seen in the case study showcasing Leonardo’s behavior in his trade. This type of bias is basically when a trader claims all the success and attributes the success to himself alone without accepting blame for the failure and tries to shift the blame to other things. In the case of Leonardo, instead of him to accept his mistake and learning or accepting that he made the wrong decisions in the market by letting his emotions and other biases to influence his trading decisions, he began to blame it on the stop-loss and blame the creators of the stop-loss concept by saying stop-loss is a dump concept because the stop-loss triggered after the price fell to that point which made him lose money. Instead of Leonardo accepting that he made the wrong decision and accepting the loss, he showed his Self-Attribution Bias by blaming his loss on the stop-loss.
Emotional Bias
In my opinion, this is also another bias that can be seen from the case study showcasing Leonardo’s behavior on his trade. This type of bias is basically when a trader allows the emotions or feelings to control the trading decision. In the case of Leonardo, he allowed his emotions to get the better of him in making his decisions which proved to be the wrong decision that made him lose money from the investment. If he didn’t let his emotions take control or influence his decisions, he would have probably sold the coin much earlier when he was in profit and taken profit, instead his feelings wished he bought earlier at a lower price and the feeling of wanting more profit led him to begin to buy at lower prices. Or, he would have just held the coin much longer without setting stop-loss. If he didn’t allow his emotions and feelings of fear to lead him to set stop loss, he would have probably made even more profit when the price increased.
Bounded Rationality Bias
This is also another bias that can be seen in the case study showcasing Leonardo’s behavior in his trade. This type of bias is basically when a trader makes certain decisions that he sees as good enough or decisions that satisfy a certain rationality, instead of making decisions that are optimal, making the best decision possible, rather the trader makes decisions to satisfy rationality. In the case of Leonardo, he allowed the bounded rationality bias to affect his trading decisions. His rationality is always to dollar cost average down so that when the price goes higher, he will be in big profit or break-even. While this can be a good decision in many situations, it is not always the right decision because if Leonardo sold his coins earlier when his asset value was high, he would have been in profit. Also, when the price was continuing to fall, he would have just taken very little profit or very little loss and moved on. Instead, he always believed in the idea of keeping buying low if the price kept falling, and that was what led him to a loss.
How Each of The 5 Biases Can Be Avoided?
Based on the case study I gave about Leonardo and his emotions in the crypto market and the different biases that influence trading decisions, we'll be taking a look at how each of the 5 biases mentioned in the previous post can be avoided.
- To avoid the “Herd Mentality Bias”, the trader should not enter a trade because every other person is entering that trade. Simply put, a trader should not buy a coin because other persons are also buying the coin. The trader should do their due diligence to research any coin before buying. Proper fundamental and technical analysis is very important. If Leonardo had done the proper fundamental analysis and technical analysis, maybe he would have seen some reasons not to buy the coin and would have bought another better coin that would have made him more profit.
- To avoid the “Confirmation Bias”, the trader should focus heavily on fundamental and technical analysis before making any trading decisions. If Leonardo has done proper fundamental analysis and technical analysis, he would have seen some signals on the chart that meant that the market would go in a downtrend and he would have sold much earlier.
- To avoid “Self-Attribution Bias”, the trader should always take the blame for the failures. In cryptocurrency trading, there are always losses, but good traders learn from their mistakes and move on. If Leonardo didn’t have the Self-Attribution Bias, he would have learned a long time ago and it would have probably not been repeated because he would have learned. But because of his Self-Attribution Bias, he keeps making the same mistakes and blaming it on other things.
- To avoid “Emotional Bias”, the trader should not let his feelings take control of his actions and trading decisions. Sometimes fear makes a trader make wrong decisions. If Leonardo hadn’t let his Emotional Bias influence his decisions and actions, he would have made a profit.
- To avoid “Bounded Rationality Bias” the trader should always think logically through the use of proper technical analysis. If Leonardo didn’t satisfy his bounded rationality which was to always buy the dip and aim to make more profit, instead, make use of proper technical analysis to find out signals on when to exit the trade, he would have made more profit or at least greatly reduced his losses.