Info!! Trading Psychology Challenges - 8: Complacency Together With Overconfidence

Unless yous equally a trader operate amongst a consistently high hitting charge per unit of measurement on your trades--far in addition to away the exception inwards directional trading--then you're probable to experience sequences of winning in addition to losing periods exactly equally a necessitate chances occurrence.  The noisiness of markets, which way the presence of flows from unlike participants at unlike times, ensures that adept ideas volition sometimes non work.  H5N1 major work for developing traders is that they neglect to distinguish betwixt periods of losing coin in addition to periods of trading poorly.  This leads them to continually alter their trading in addition to endangerment taking, eroding their probabilistic edges.

There is a flip side to this problem, however, in addition to that is allowing strings of winning trades to skew forwards endangerment taking.  Falling prey to the "hot hand" fallacy later a winning period, traders falsely assume that they similar a shot cause got a much larger border in addition to expand their endangerment taking.  They size positions unusually large and/or accept many to a greater extent than positions.  As a result, when the inevitable losing trades occur, these wipe out large amounts of the prior gains.

It is non odd to encounter traders oscillate betwixt sloppy in addition to complacent trading later winning periods in addition to overcautious in addition to endangerment averse trading later losses.  This way that they are most probable to lose when they accept to a greater extent than endangerment in addition to most probable to follow rules in addition to merchandise carefully when they accept less risk.  This recency bias ensures a downward skew to P/L over time.

Complacency later winning periods tin exhibit upwards inwards other ways equally well.  Traders tin larn less focused inwards their interrogation in addition to training next profitable runs.  They tin likewise allow positions remain on their books without careful periodic review, allowing those "stale" positions to surprise them past times reversing on unexpected intelligence or flows.  

The primal to avoiding overconfidence bias is to actively sentiment winning periods equally risks to futurity trading.  This is counterintuitive, equally human nature is to experience adept close succeeding.  If, however, yous are actively reminding yourself that wins tin lull yous into carelessness, in addition to thus yous cause got an effective prod to double downward on the essential elements of trading process.  An do I've constitute helpful inwards this regard is to visualize that the recent gains cause got instead been recent losses.  How would yous endure preparing for the hateful solar daytime inwards that event?  Would the trades you're contemplating when you've made coin likewise endure ones that yous would accept if yous had experienced losses?

A mutual error at trading firms is to allocate capital/buying ability to traders later winning periods in addition to cut down capital/risk later losses, when such stretches of losses in addition to wins are solely expectable given the trader's historical Sharpe ratio.  It is non at all odd to encounter a trader wipe out prior gains past times meaningfully bumping upwards endangerment taking later a profitable period.

Ultimately, traders larn vulnerable when their feelings close themselves in addition to their run are tied to short-term returns.  As I noted inwards the 2.0 book, 1 of the greatest strategies for avoiding recency bias is to cause got sources of happiness, fulfillment, in addition to unloose energy exterior of markets in addition to thereby ensure that trading fits into your life in addition to non the reverse.  We larn vulnerable when our recent returns dictate our electrical flow moods.

Further Reading:  Understanding Our Biases inwards Processing Emotions 

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