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Trading and Brokerage
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Why you don't want to be lucky

On Why making money on your first few trades may not be the best outcome

 


“The potential for temporary success by pure luck beguiles people into thinking that trading is a lot easier than it is. The potential for even temporary success doesn’t exist in any other profession.

 

 If you have never trained as a surgeon, the probability of your performing successful brain surgery is zero.

 

 If you have never picked up a violin, your chances of playing successful solo violin in front of the New York Philharmonic is zero.

 

It is just that trading has this quirk that allows some people to be successful temporarily without true skill or an edge—and that fools people into mistaking luck for skill”

 

- Quote from "What I Learned Losing a Million Dollars" by Jim Paul and Brendan Moynihan

 


Luck or skill?

The quote above, which is from the true story of the rise and fall of Jim Paul, sums up trading. It’s an occupation that you don’t need any specific qualifications to pursue.

 

However, unlike most “unskilled“ roles, the potential rewards in trading are substantial. In fact, they are open-ended or without limit if you prefer.

 

Of course, the key word in that sentence is potential because until they are realised those rewards will remain out of reach, tantalisingly close but just beyond our grasp.

 

Realising those rewards and doing so regularly will usually require hours of dedicated study and application, combined with the ability to follow a set of rules and the discipline to apply them every time you trade.

 

There is an old saying among traders and gamblers that they “would rather be lucky than good”, but this is wrong because as Messrs. Paul and Moynihan point out, people are very quick to mistake luck for skill.

Falling into a trap


To do that is to fall into the trap of outcome bias that is judging the success of an event or action purely on the results generated, rather than the journey taken to get to that endpoint.

 

Annie Duke, the famed poker player and author of “Thinking in Bets” calls this “Resulting”.

 

Yes, trading is about making money, but more importantly, it’s about making money without taking on excessive risk. It's all well and good picking up nickels and dimes you find in the street, but you wouldn't (or shouldn't) want to do this in front of a steamroller.

 

The ability to recognise, measure and quantify risk is a key skill for any would-be trader. Unfortunately, it’s a skill that must be learned the hard way, which in trading means losing money.

 

Harsh lessons

Losses are a fact of life in trading. They are part and parcel of the job description, and the trader must come to terms with that, and the sooner the better.

 

Here's the thing. In an ideal world, those new to trading should experience several consecutive losing trades. They should feel the pain and disappointment of seeing their money disappear and their ideas going up in smoke, however, by learning from their experiences, they should go on to be a better trader.

 

This may sound harsh, but there is no substitute for having skin in the game and losing money. It focuses the mind like very little else.

 

If we have correctly approached the markets from the outset (that is, conservatively), we should be risking only a small portion of our capital on any one trade, and only having a limited number of trades open any one time. Then these losses will be akin to scratches and scrapes and not mortal wounds.

 

 

A biased picture

 

Therein lies the crux of the dilemma we face as traders. If you are lucky and you make money straight away from your first few trades, you can develop a false sense of security.

 

You will overestimate your own abilities and fall victim to another bias, that of anchoring.

 

When our mind tricks us into anchoring, we carry an incorrect assumption or set of assumptions forward into future decision making. In turn, this can lead to availability bias where you make decisions and form opinions, based solely on the information in front of you, rather than considering the bigger picture.

 

To put this into context, let's imagine that you start trading in the live markets and you are fortunate to have US$ 10,000 in your account.

 

For your first trade, you take a “flyer” by going long two lots of an FX pair (that's US$200,000 of underlying notional value) You trade without a stop loss and then you head off for nine holes on the golf course.

 

By the time you return to your desk, the markets have shifted after a key central bank announcement.

 

By complete chance, because that's what it is, the markets have moved in your favour and you close out your position for a tidy profit.

 

That might sound like a good day's work, but it’s a disaster or at least a disaster in the making simply because you broke so many rules around money and risk management.

 

You didn't consider the leverage involved in the trade, the relative size of the position to your account balance and by not having a stop loss on the trade, you put all your trading capital at risk.

 

Finally, you didn’t check the calendar to see if any key data was due out and you left your position unattended while you played golf.

 

Make money but in the right way

We are not saying that we want you to lose money, on the contrary as your broker we would like your account to grow and for you to recommend us to your friends and family.


Ideally, as your partner in the markets, we want you to make money in a sustainable, systematic and thoughtful fashion, one that rewards best practice and encourages good habits, not bad. A trader placing small trades across ten years is worth far more than an easy-come easy-go trader who treats it like a visit to a casino.

 

A little discomfort in your first few trades can go a long way to achieving just that.

 

25/03/2020
Market Analysis
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Why Your Stop Losses Are (Probably) Wrong

When you start to learn about trading, you'll come across plenty of material about minimising risk and money management, because they're two of the most critical areas of the business. 


Learning to manage risk and preserve trading capital is fundamental to a successful trading journey. 


One area the literature focuses on is the use of stop losses. A stop loss is simply a price level beyond which you choose not to run an unprofitable or losing trade.


But for me, stop losses are one of the most misunderstood tools in a trader's arsenal, and I wanted to offer a different perspective than what is usually found in the research.  


I'll give you a hint; it's in the name!


Knowing your risk

It's important to know the risk you are taking on any given trade, this can be calculated by multiplying the distance of your stop loss, from the entry-level of your trade, by the notional size of your trade.  


In theory, this simple calculation determines the maximum risk or loss that you face on a given trade. I say in theory because that risk figure is not cast in stone.  


Firstly, if the stop loss you use on a trade is just a mental one, i.e. a figure that you have chosen, (but will watch rather than attach to an order), then it will be down to you to monitor price action and trade it. That's a sure recipe for looking like a maniac checking your platform or mobile app every second you get.


Systemise your process

Rather than rely on them being in front of the screen to close a trade (which in a 24/5 market is not that realistic), many traders will place a stop loss to an open position. This is essentially creating an instruction to close the position should the price of the underlying instrument reach a pre-set level.


In doing so, traders are systemising this part of their trading. On the face of it, that sounds like a good idea doesn't it? 


But what if that automated stop loss level was defining the loss you make on a trade and eating away at your trading capital, not protecting it?  


The use of a stop loss should be what its name suggests – the prevention of a loss, not the realisation of losses as 90% of traders currently use their SL for.  


Crowding together

Here's the thing. Traders of all sizes fall foul of "clustering" which means they place their stop losses in the same areas, at the same time.  


For example, at or around round numbers, (e.g. USDJPY 110) just above or just below a moving average or indeed close by the same support or resistance levels everyone else is keenly watching.  


The market is aware of this behaviour and is often on the lookout for these clusters of stop losses. When they are, it's known as a stop hunt.  


But what exactly does that mean? 

Well, a big bank (a price "Maker") might see on their books that they have a cluster of orders around 1.10 on EURUSD, and then be willing to commit large sums of capital to "hunting down" that stop loss level. They do this by moving the underlying price towards it, in a selfish way, to reward themselves, rather than because of natural order flow (and they wonder why they have bad reputations!).  


As an aside, a broker such as Fusion Markets, that typically services "retail" clients, e.g. mum and dad investors, often get accused of doing the same thing, despite the fact we are a price "Taker" not a price "Maker", and have no control over the prices coming through to you, as a client.  


Think about it if the market can find these groups of stop losses and trigger them, then that's easy money for the banks and traders who have the opposing view and positions.  


Remember that in FX trading there is a winner for every loser and vice versa. A successful trader endeavour's to be on the winning side of that relationship more often than not.


A different approach to stop losses

Are we saying then that you should trade without a stop loss? No, we are not! 


But what if we took a different approach to stop loss placement? Instead of lining up to provide a free lunch for the banks, what if we placed our stop losses above our entry price rather than below it?   


Of course, that means that we'd have to risk-manage our trades in a different way.


For example, employing less leverage and taking smaller positions relative to our account size. But that is really what we should be doing anyway. And of course, we would have to monitor performance closely in a trade's early stages, as we should.  


However, if the trade we have taken is the correct one, then our position will soon be on-side, and once we have a buffer between the current price and our entry-level. Then, our stop loss can be locking in profits rather than minimising (or realisation of) our losses.  


Trailing a stop-loss behind a profitable position is something of a holy grail in trading it's often talked about, but rarely seen in the markets. By not acting like the crowd, maybe we can turn the tables on the stop hunters.  


What are you waiting for? Why not stop your losses in the way they're supposed to be stopped? 





23/03/2020
Trading and Brokerage
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The Seven Most Common Mistakes I’ve Observed Traders Make

 I’ve been in this industry for over a decade now and have been in a very fortunate position to learn a lot by watching others. I’ve seen the good, the bad and the ugly by watching tens of thousands of traders across various brokers.


Let me start off by saying that I am by no means perfect and I have (even recently) done quite a few of these myself. But knowledge is power, so I wanted to provide my observations of where things can start to go wrong, based on my own experience of sitting on the sidelines.  


1.      Ignoring Basic Risk Management aka Trading too big for their accounts


I have to start with risk because I believe it’s THE most important concept.


"Risk is what's left over when you think you've thought of everything" 


Unfortunately, risk management is not sexy, however. It makes people fall asleep when you hear someone talk about risk management.


Risk can mean many things, but it’s especially prescient when it comes to Forex Trading due to the leverage that’s involved. Unfortunately, it’s a gift and a curse.


I always tell traders that leverage is like driving a fast car. It’s nice to know you’ve got that power if you want to use it. And most of the time you don’t want to (nor should you) drive 100km/h on a busy street.


That is how I best describe the use of too much leverage.


It’s great that you have the flexibility with it if you need it, but you shouldn’t be maxing out the margin on every trade. It gives you less flexibility if the trade goes against you and kills way too many traders too soon.


I’m not a big fan of martingale systems and have seen this ruin many traders; however, depending on the circumstance, I do enjoy averaging into a trade. After all, if I liked buying EURUSD at 1.1000, wouldn’t I also like it at 1.0960 where I’m getting a lower average entry?


Many forex education providers will advise you never to risk more than 1% on any trade, and this can be good advice, yet I’d say more than half of traders I’ve seen will routinely trade at least 10x that. Some will even come close to margin call triggers on the first trade. Frankly, this can just be like lighting money on fire.


It might not be as “fun” to trade when it’s so small. But if you’re getting too excited by it all, maybe you’re taking on too much risk.

 

2.       Too many trades/ Trading outside of the area of competence


A close cousin of too much risk is taking too many trades, or branching out into other areas.


There’s a reason that doctors specialise in one area. You’d probably be scared if you saw an eye doctor have a go at performing surgery on the brain.


Stick to just a handful of products at the time (I’d say a maximum of five, preferably three). If there is a correlation between them, that’s fine but don’t assume your knowledge of the yen will mean you’re a great trader of the Turkish Lira.


In most investment banks back in the day when they had large proprietary desks, traders would only stick to a few currency pairs. You’d be on the “yen” desk or the “sterling” desk. That makes much sense as there’s only so much information you can absorb.


If I see a client that is successful trading in currencies who then makes a jump to the Indices it often is a sure sign of trouble ahead.

 

3.      Getting caught up in FX Headlines/Mainstream Media


Many will disagree with me on this one, but following the same headlines as everyone else in forex trading can sometimes lead you astray.


Yes, you need to be informed about what’s going on. You shouldn’t stick in your head in the sand.


Howard Marks said it best when he remarked: “You can’t do the same things others do and expect to outperform”.


If you’re reading Bloomberg headlines saying so and so thinks EURUSD is heading to 1.10, then every man and his dog is reading the same thing. Ask yourself what do you know that isn’t already baked into the price? How can you have the edge over someone else? Is it really by consuming the same news like everyone else?


Being contrarian in life might make people think you’re strange, but in the financial markets, I find it invaluable. The markets are (mostly) efficient, and a lot of what you see is already factored into the price. You need to think differently to the market if you want to get ahead. Remember the GBP after Brexit? Analysts were calling for parity against the USD. You’d be crazy to buy it people said. Fast forward, and it was probably one of the best trades you could’ve made once the negativity died down.

 


4.      Not using a Demo


This is a pretty standard one, but if you’ve started trading without using a demo first then you’re asking for trouble.  


Do think you can be a pilot after a day of flying lessons? Then when you’re risking your money, you can't be expected to perform well in the markets without doing some practice first.


It takes a lot longer than people think to master their craft at trading and many mistakes on the way.


That being said, you can also spend far too much time on a demo and never understand the psychology of a real trader with real money and emotions on the line. So do practice, but just like when you learn to ride a bike, you will need to take the training wheels off at some point. That’s why we recommend having a demo and a live side by side (and Fusion offers unlimited demos for funded accounts)

 

5.      Moving Stops and Limits


Ah, the old “Greed and Fear” comment. Lots of people will talk to you about how two things kill a trader/investor, and that’s greed and fear.


Good trading is about good entries and exits.


Traders I’ve seen have spent much time setting up the perfect entry, but then they don’t have an exit plan.


The trades go well for them and then all of a sudden, the greed sets in. Suddenly, their take profit has been bumped up just a little bit higher to capture that extra drop of profit. Then boom! All of a sudden, the trade has reversed, and their profits have disappeared faster than you can say margin call.


Trading without stops and limits is also just as bad. You never know what “black swan” can happen while you’re away from your platform or are asleep. Having protection in the form of stops and limits can help minimise your risk. You can also try to use “trailing stops” which move up as the price moves in your direction. Ask me how if you need a hand with these.

 

6.      Ignoring the important of Psychology


You might’ve read my other posts about biases and psychology. But my personally believe that life is 80% psychology, 20% strategy and I believe trading is no different.


If you can master your trading psychology, you’ll be a far better trader for it.


This is everything from being too afraid to enter a trade, to being too greedy to close it to learning even more about all the biases we have and how to prevent them.


 7.     Not having a strategy 


Yes, I believe trading is 80% psychology. But you still need the 20% that comes from a strategy.  


What is your strategy? Why would (or should) that give you an edge? How long has the strategy been successful for? Is it technical or fundamental based?


You know the quote – if you to fail to plan, you plan to fail. You can’t show up and hope for the best. You’ll get killed. That’s where testing comes in whether that’s via a backtest of an algorithmic strategy or if it’s just applying the strategy on a demo. Or even just starting small with micro-lots.


You need a strategy if you’re going to succeed.


Sure you might get lucky for a little bit, but it won’t last forever.

 

Overall, this isn’t a definitive list and unfortunately, following it blindly is no guarantee for success in the markets.


We all make mistakes. I know I do – all the time. But I hope that the above is useful for you as I’ve had a window into watching traders for a long enough time.


Did I miss any? Was there something you thought was even more important? I’d love to hear from you.

 

 


16/03/2020
Trading and Brokerage
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That which does not kill us

“That which does not kill us makes us stronger” – Friedrich Nietzsche.


It’s a cheesy quote to start with, I know. Bear with me here.  


It turns out it might be true when it comes to professional success as well.


In a recent paper published in the journal Nature, researchers found out that early-career setbacks can result in a stronger career in the long term – stronger even than people who never had a setback.


To sum up the paper in just a few lines, the experiment compared two groups of scientists: a group that scraped over the line in getting a grant from the US government and compared that to a group that had just missed out on a grant (one that just made it, one that just missed out).


Ten years later, the group that had not received the grant went onto have more successful careers than the team that had won the government grant.


So those who’d experienced some pain early on in their careers went onto come back stronger than those who didn’t fail.


I couldn’t help but think of how that pain would’ve fuelled their success in later years and how that so encapsulates what I’ve seen in over ten years of trading and watching hundreds of thousands of traders.


Why early successes in trading could hurt you


You may have seen my thoughts on Overconfidence bias before and it got me thinking how much this could spill over into early successes trading.


I’ve seen this far too many times in traders before.


It’s like the story of the tortoise and the hare. It’s the slow and steady trader that wins the race.


The traders I’ve seen who are new to trading will open their accounts, ignore basic risk management and trade gigantic positions on their account and make huge profits on their first few trades. While I love to see it, often they lull themselves into unbelievable amounts of overconfidence and a feeling of invincibility.


They’re the stories you read like “one man makes $1,000,000 trading options on first trade” or “this is how much you would’ve made investing $1 in Google shares since 2004” or “my friend just made $15k betting on AUDUSD” or other financial “junk food” as it should be labelled.  


Because it is too easy in their eyes, they’re always chasing the same early successes they had. 


What I took away from the Nature paper is that the easier we think something is, the more we can fool ourselves into believing something which isn’t true.


Taking the pain


Let me be clear. I’m absolutely not saying that you must lose big to win big. Nor am I saying making money early is bad.  


I’m saying that in my experience, my firm belief (now backed up by some solid research in a different field) is those that suffer early setbacks in their trading are like those who just missed out in their professional lives. In the same vein, if it’s too easy at the start, you can hurt yourself and trick yourself into thinking you’re better than you are.


It’s more like you need to hit some minor lows to hit the highs, but don’t ruin yourself. Call it a bloody nose.


Trading is not some easy game that can be won in the first week or month. Just like you wouldn’t expect to be a pilot after one week of flight training (though you can certainly have the goal!), the same is true for trading.


It’s hard. Very hard. There’s so much to take in and digest. The market is constantly evolving. That’s why you’ll hear statistics like 40% of traders don’t make it. Most people expect too much and give up too soon.


But real success in trading is more like a way of life.


It involves hard work, true grit, hours upon hours of learning and the ability to look and feel wrong many, many times (and often in painful ways both mentally, financially etc).

If you are just starting and you’re shooting the light outs, then maybe that’s not such a good thing. And if you’re struggling, know that you’re not alone.


Far better for you to see it as the challenge that it is. That a little pain is part of the journey and that if it were so easy, everyone would be doing it.


17/02/2020
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Top 10 Hidden Biases Part II

Part II – Hidden Biases in your trading

In Part One, we covered Confirmation bias, recency bias, the endowment effect, the groupthink bias and the gambler’s fallacy.


Today we’ll cover our final five, and I’ll provide you with a handy checklist so you can take 60 seconds and potentially stop yourself from rushing into something catastrophic.


6)    Hindsight bias

You could also call this one the “I knew it all along” effect. How many times have you heard someone say those words in life (not to mention in trading)?


I just knew Euro would fall after the ECB meeting.


Argh, I meant to go long on gold but didn’t get time. I knew it was going up.


We tend to believe that (of course much later than the event itself) that the onset of a past event was entirely predictable and obvious, whereas during the event we were not able to predict it.


Due to another bias (which we will not cover today) called “narrative bias” we tend to want to assign a narrative or a “story” to an event that allows us to believe that events are predictable and that we can somewhat predict or control the future. It allows us to try to make sense of the world around us.


How to overcome: Just stop pretending like you knew what was going to happen. If you didn’t put skin in the game, then you didn’t think it was going to happen!

 

7)    Overconfidence effect


Overconfidence as a trader allows us to believe that we are superior in our trading, which ultimately leads to hubris and poor decision making.


Whether it’s overconfidence on when to trade, what to trade (telling ourselves “sure I could normally trade AUDUSD, but why couldn’t I also be good at trading the South African rand?”) and how to trade a certain product.


We trade larger than we should, hold losers for longer than we should, relax our own risk management policy, become arrogant or complacent in our trading and this all leads to capital losses.


How to overcome: Ask yourself “What could I be wrong about” or “What makes me think I am far superior to all the others out there with this information”? The market will humble you eventually of course, but why not try to do it yourself before you shoot yourself in the foot?


8)    Anchoring


The first bit of information we hear is what we focus on.


If you ever need to negotiate with someone, you’ll be amazed at the power of anchoring with your first offer (Do try it sometime, just not with your friendly forex broker though ;-))


The same applies to trading. We hear a talking head on TV telling us about how the euro is overvalued and is heading for some drastic number that is streets away from today’s price. We can’t get that number out of our head even if we try.


Or let’s say we buy AUDUSD at .7100, close it at .7300 for a decent profit, happy days! The next week, it’s back at .7100 and we immediately are tempted to do the same again, because why not? It’s cheap again and we can repeat history. We rush into it, ignoring the technical break it’s just had or the negative sentiment on Australian Economic Data. We practically feel it’s a bargain at those levels.  


What do we do? The worst part is that we’re usually not even aware of how strong the influence is.


That’s the power of the anchor. We become attached to that information.  


How to overcome: This one is tough to overcome because studies show it can be so hidden in our subconscious without us knowing. Perhaps add to your trading checklist “Was this trade a result of an unknown anchor that I saw or heard?”


 

9) Consistency Bias

Like the sunk cost fallacy, we want to be consistent in our actions.


We’d hate for someone to say to us that we weren’t being fair or that last week we had said we’d do X and now had changed our minds.


Politicians do it all the time as they rigidly stick to a poor policy idea. They’d rather go down with the ship.


Traders are worse because our own desire to be consistent costs us money.


If I am known as a USD bear, and it’s rallying hard – I don’t want to look stupid or inconsistent. That’s why I keep staying bearish despite being 1000 pips from being right! It’ll come back we say. Everyone else is being stupid.


In 2009, 2010, 2011 and probably countless years since the financial crisis, people were always calling for the “double-dip” recession. I fell for it myself personally by believing them in 2009 and 2010 and staying too cautious when I should’ve thrown the house at buying stocks!


We want to feel in control. We want people to see our conviction, even if we’re wrong. Because this is a byproduct of confirmation bias, we’re not likely to seek disconfirming evidence of what we believe. We see what we want to see.


Why? Because sadly consistency is often associated with our intellectual and personal strength. Good traders should be seen as flexible. Open to the idea that they are probably wrong. Yet society thinks an inconsistent person is flaky, confused or a ‘flip-flopper’ on issues – even though we could all benefit from being open-minded to new ideas and opinions!

 

10) The Halo Effect

Last but not least - The halo effect is the final bias we’ll talk about today.


The halo effect means we let our overall impression of someone influence our thinking too greatly.


“But he’s so smart we say”


We idolise the opinions of the legendary hedge fund manager, Ray Dalio or the great investor of our time, Warren Buffet.


We see them on TV or in a Bloomberg article saying now is a buying opportunity or that it’s risk-off and we need to sell.


“If Buffet/Dalio/ is buying/selling now, I’ve gotta too,” we say in our head.


But how smart is that a strategy, really? What might he know that I don’t? What are his investment objectives versus mine? More important – how many times has he said this and actually been wrong?


We don’t know and we shouldn’t try to know. The halo effect blinds to sticking to our own plan and staying in our lane. The more we’re influenced by others, the harder trading becomes.


How to overcome: We must take the opinions of the so-called “Masters of the universe” with a grain of salt. They have different plans than we do. Information that we do or don’t have and so much more. Just because they’ve said this doesn’t make it come true. If only trading were that easy!

 

What do I do now?


OK, so I might have scared you. You are now jumping at shadows and questioning your own trading decisions, believing you have all these secret, hidden disadvantages that you didn’t have until 10 minutes ago.


Do not worry, biases can never be completely avoided. But we can work hard on challenging our opinions in order to make us more successful. Sometimes it’s just taking the time to stop and think.


To help you along the way, we’ve created a possible checklist for making better decisions in your trading.


So, stop, take a breath and ask yourself these 7 questions before you place your next trade.


What’s the rationale for taking this trade? List 3 for and 3 against.


How strong is the evidence behind my decision to trade?


What are the possible unknown unknowns?


Has the recency of information I’ve learned influenced my decision? If so, how much?


 Is this trade following the consensus of the crowd? If so, is that a good thing?


Did I hear this from a famous market commentator/investor? Why is that important?


 If none of questions 1-6 apply, then could any of the other biases above be at work?


 


27/01/2020
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Top 10 Hidden Biases Part I

Your first reaction as you read the subject was thinking: “Yeah, but I’m not biased”

Of course, that’s what you would say!

The biggest problem with biases is that we never think we have any.

Biases are what everyone else has.

What are they and why are they important?

Biases are like shortcuts for your brain. They can have an unusually large impact on how you make decisions in your everyday life, but particularly when it comes to your trading.

To put it simply, your brain has a way of conserving energy by making fast decisions or mental shortcuts in what is known as ‘heuristics’.

The problem is, we often don’t even know that we have them. Even if we know about them, when it comes to trading, we must work hard to challenge our reasoning behind making our decisions.

As common as these biases are, we specifically want to focus on what is called “cognitive” and “emotional” biases.

Because these are so crucial to your trading, we’ve split this guide in two. This is part one.
Biases have been studied across psychology, economics and now into the mainstream of what is called “behavioural” finance. In fact, Richard Thaler, a notable behavioural economist recently won the Nobel prize for his work on the topic!

The sad part is that I know more about this topic because of my own mistakes in trading and so I try to be hyper-aware of rushing into trading decisions without considering the biases below.

The million-dollar question becomes, how many of these have you been a victim of and what can you do to try to prevent them yourself?
 
1)     Confirmation bias

This one is a doozy and for me, the most important of all of them.

If you take nothing else from today, it should be an awareness of confirmation bias.

Confirmation bias means we tend to seek out information only that we agree with.

Ask yourself this question: How many times have you placed a trade then sat there and watched it go against you? Sure, this happens almost every time, but then how often have you then gone out and sought information, headlines or “expert” advice about that currency pair which tells you why you were right and to just stick with it?

I remember many years ago, when I first started trading, I placed a fairly large trade on oil (don’t ask why I made this trade. I had no idea what I was doing and it was too big for my account... Forgive me, I was just a beginner!) but as soon as it went against me I frantically typed “Oil” into Google, and just like that I was looking for any reason to support my original opinion on why oil was due to go through the roof.

To my joy, there was some analyst from ABC Fund manager comforting me with a view that supported my own opinion or perspective. They talked about an undersupply in the market and that oil was sure to go higher. It was 2 am and I was sitting in my lounge room by this stage as I watched my whole account go into jeopardy. This valuable advice that I sought helped to nurse me back to sleep.

I, of course, deviously chose not to click on any article that might tell me I was wrong – I only sought out the information I wanted to hear or see.

Let’s just say that the oil trade I placed went as well as a parachute made of concrete! (Oh and my account was completely wiped out!).

How to overcome it: Stop, ask yourself a question – What information could you be missing about the rationale for this trade? What do the opposing arguments and research say?

2)    Recency bias aka availability heuristic

The “recency bias” or “recency effect” essentially tells us that our recent experience can become the baseline for what is going to happen in the future.

This might mean our recent trade performance such as a recent win or loss impacting us heavily. It might also mean a certain piece of news or information that we recently heard forming the basis for our decision making.

This can have seriously dangerous consequences for us as traders as it undermines our ability to form an objective decision on a trade. Why? Because of our lazy brain only recalling recent information. Whether that’s on our most recent trade or information we found as a barometer for how the next trade will go.

Let’s say you had a losing trade whereby you promised you’d never risk such a great amount of your capital again. You might be a little shy and dial back the risk a bit too much, or you could be the opposite and think you’re George Soros, betting the whole house on the next trade since you just went so poorly on the last. Your thinking is this would get you back to where you were prior to your last trade.

The other way it can creep into your trading is through recent information impacting your decision on why to take a new trade. It might be that you see a brief news headline stating ABC bank’s research on “why the dollar is going to dive this week” earlier in the day and tend to argue with yourself later that night why you think it’s a good idea to follow that trade. I know what you might be thinking: “It’s just a headline… I’d never let this happen to me”. However, our brain likes to take shortcuts to conserve energy. It will do its best to take what it knows and ignores the rest (as we have learned above).

We also have a tendency of the fear of missing out (FOMO as it’s popularly known today) and with this new information, we feel we must put something into action!

How to overcome the bias: As difficult as it may be, you must stop, count to three and ask yourself a few questions.

These could be “why am I making this trade?”, “Does it fit in with what I know?”, “What am I missing here?”, “Have I read something recently about this?”. Better yet, build yourself a checklist with these questions on it!

3)     The Endowment effect / Sunk cost fallacy

The endowment effect means we tend to value something more after we’ve owned it for a while.
In a now-classic study featuring Richard Thaler and Daniel Kahneman (both Nobel prize winners), students were given a mug and were asked how much they would sell it for an equally valued pen as an alternative. The experimenters found that the median price for which they would sell was TWICE as much as they were willing to pay to acquire the mug.

Because of our aversion to losses (also known as prospect theory – another big bias which I’ll cover later), this can have a drastic effect on our trading success. We place a trade on AUDUSD, with a target profit or loss of only 50 pips. Yet when the trade starts to go against us, what’s the first thing we often do? Move our stop loss further out because we “just know it’s going to turn around.” We tell ourselves stories like “The euro is cheap here, it’ll definitely turn around.”

Because we are committed to this trade (and this is somewhat related to the confirmation bias) we value it more just because we own it and because we have already invested in it, it becomes a “sunk cost”.

How to overcome: Fairly obvious advice to start; keep your stop losses and targets where they are. Be more mindful about why you’ve put them at these levels. If it helps you, write down the reasons why you’ve placed your stop and profit there and you can take comfort in understanding your own reasoning.

4) “The Gambler’s fallacy”

The gambler’s fallacy is where we believe that future probabilities are altered by previous events, when in fact, they’re unchanged.

It is called the “gamblers fallacy” due to the often-watched scene of any table game at the casino (e.g. roulette) as it continues landing on black over and over. People see this and think ‘it couldn’t possibly do that again’ and try to bet against it.

Being contrarian is great, don’t get me wrong.

However, as traders and human beings, we tend to believe that if something happens multiple times, it couldn’t happen again. We ignore simple probability.

Let’s say the S&P500 has rallied five days in a row. We place a trade in the belief that “it must be due for a correction” only to watch it rally and stop us out of our position.

How to overcome: It is important to look at the original thinking that led you to this trade. Just because something has moved up or down in a continuous fashion, it does not mean the market will immediately reverse its behaviour and go the other way. Just try catching a falling knife and you’ll know why.

5)     The Groupthink Bias

The “groupthink bias” is our inclination to do or believe things just because others do the same. Also known as the “bandwagon” or “herd behaviour”, it can lead to having a serious trading hangover; ask yourself an odd question like “why on earth did I go long the EURCHF last night?”

After all, you can’t do the same things others do and expect to win.

A recent example was after the US Presidential election. Everyone thought if The Donald got in, it would be a huge negative for the markets and the economy. Stocks fell initially and hard.

If you cashed out then and there because you thought it was going to lead to Armageddon, you made a very expensive mistake!

How to overcome: Sometimes it pays to be contrarian. If everyone is saying it’s going up, consider if going the same way will lead to riches. If everyone is saying it’s going down the toilet, consider if they could be wrong.

Be careful of those bandwagons!

So, which of the above are you most guilty of?

20/01/2020
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