Behavioural Biases and Trading Psychology

In regards to trading psychology, this is probably the hardest aspect to master.

In reality, it is far easier to digest the various economic theories and master trading fundamentals than it is to actually recognize and change your own behaviours. Essentially, humans are quite irrational and our decision-making processes are often affected by a number of behavioral biases. Have a read through the list of biases on Wikipedia and see how many you recognize in yourself.

Loss aversion is an interesting one in both the financial and gambling markets. Somebody may claim that they are risk averse, when in reality they are ‘loss averse’, and actually take on more risk in order to avoid a loss.

There is an asymmetric relationship between how we react to losses and how we react to gains, such that we feel losses much more than gains. We see this manifest itself where people will keep a losing position open in the hope that it will turn around, but at risk of making a larger loss, yet the same person will close a winning position early and lock in a reduced profit. I’m not necessarily saying that locking in small profits and risking large losses is always wrong, as things should be evaluated on a case by case basis, but behaviours such as this can distort and erode the value you find elsewhere.

Other biases to be careful of are overconfidence or optimism-based effects, and, if you spend too much time on social media, the ‘fear of missing out’ which may lead you to over-trade, entering into questionable positions, trading out and paying spread costs/commission again eroding value.

Controlled aggression is a great strategy to alleviate some of the ups and downs of trading and to keep within a more positive mindset. One such strategy is the concept of a pyramid based portfolio, with a large, solid, low risk base at the bottom, and smaller more speculative layers on top. As you move up the pyramid, each layer gets smaller, but adds more risk and the possibility of higher returns. The intention is here that income from lower levels provides enough upside to cover any losses on the more speculative layers.

IT WILL GO WRONG!

Lastly, try to be aware of the probabilities and the real likelihood of both exceptionally good and exceptionally bad runs. We are very good at misinterpreting probabilities. The likelihood of losing a fair coin toss 5 times in a row is actually greater than 3%. If you have a large sequence of coin tosses (say 100), the likelihood of hitting 5 losers in a row gets quite large (I’ll leave calculating the exact probability as an exercise for the reader).

It’s interesting that faked experimental data can be identified by the ‘absence’ of sequences like this. We massively underestimate the likelihood of bad runs and have trouble accepting them when they occur. They will happen and there is no point getting depressed about it.

Aim to construct your portfolio so that you can weather the bad runs, concentrate rigorously on finding value, try to be aware of any behavioural biases that may be affecting your decisions, and try to develop a Zen-like attitude to the sometimes seemingly randomness of price action, and you will be well on the way to becoming a successful investor in the world of football trading.

Share This Post
IndexGain
Written by IndexGain
IndexGain, the Football Index Fan Community. Here to maximise your trading potential with player news, price moves and trader discussions.  
Have your say!
0 0
Knowledge Hub