Trading with objectivity is a struggle for a lot of us. While we understand the value of being objective and the consequences of letting unhelpful thoughts and emotions to step in, we often allow them to take charge without even realizing. We are biased and have no awareness of it. One of the most common biases in trading is “confirmation bias”, the perpetual tendency of our human mind to prove itself right. We look for information that confirms our existing beliefs and ignore information that dis-confirms it. This tendency is partly explained by the need that people have to dissolve the discomfort that arises from holding two contrasting beliefs. Psychologists call this discomfort and inner tension “cognitive dissonance”.
In other words, it is often uncomfortable to accept that we may be wrong and to admit to that, even though facts suggest so.
Confirmation bias serves the purpose of alleviating the inner tension that is experienced when cognitive dissonance appears.
But how this applies in trading?
Let’s say that early on Monday morning, before London open, a day trader analyses the market using his preferred indicators and concludes that he will go short on EUR/USD. After market open, the pair moves relatively faster than usual and on the opposite direction than expected. Trader sticks to initial plan and doesn’t make any changes but is feeling slightly worried. It’s too early to tell, so he decides to go online and read articles on technical analysis for EUR/USD. He finds a number of different articles on technical analysis for the day as well as weekly forecast reports. The data are not very clear and most analysts suggest than an upcoming news release would play a vital role in how the pair moves for today. The trader however, seeks to reduce the discomfort he experiences by confirming that the possibility of a drop is more likely; he therefore focuses on a minority of analyses that suggest this and disregards the rest. Five hours after market open and before the expected news release, the pair has already climbed 60 pips. Trader convinces himself that this must be a temporary correction and adjusts his stop loss levels lower.
In this example, the trader has followed information selectively in order to confirm his initial position. Convinced by some technical analysis reports, he has only sought data to confirm his belief that EUR/USD will drop. Not only he didn’t cross check information but he chose to ignore information that suggested the opposite.
- Have I explored conflicting information equally?
- Have I cross checked with different sources of information?
- Am I reading and interpreting data objectively or am I seeking to confirm myself?
- Is there any anxiety or discomfort that I am trying to fight by looking for evidence that confirms my position?
- What would I do if I didn’t have this uncomfortable feeling?