We All Suffer From Cognitive Bias

One thing all traders have in common is that we are all human. Which means we are all subject to the whims and flows of our emotions in our logical decision making process. If you think you are the one exception, think again. Let me explain.

A cognitive bias is a mental predisposition based on genetic traits or childhood conditioning that leads us to being subjective in our decision making.

Here is a really good example.

Back in my Silicon Valley days, just before the dotcom bubble went bust in 2000, I was working in an up and coming startup as a senior software architect.

It was a top notch team of top level performers with IQ points to spare – great minds all around.

Most of us on the team were already married (Silicon Valley is not a great place for players) but one of the guys was in a marriage he unfortunately shouldn’t have been in.

Let’s just call him Alex. He was a great laid back dude, mid 30s like us, had his act together, super smart, took good care of himself, great dad, and already in the top 1% income bracket.

Basically by all intents and purposes Alex was at the top of his man-game.

Now Alex’ wife was a different story altogether. Dyed in the wool wild child, the kind that you picture going home with the smooth talking bearded bartender who has an arm sleeve of tattoos and lives in a van down at the river.

Alex and I were good friends and from the numerous stories he kept telling me, it was quite obvious that his wife was hooking up with other guys.

One of the typical stories where after work, she went to “hang out” with one of her coworkers after work at his place until 2am. And then she called Alex to come and pick her up.

Her story was the textbook ‘look, he’s just a friend I work with’ sort of gaslighting. And he swallowed it hook line and sinker.

To the rest of us, who had met his wife, it was a sweet sour mix between the tragic and comical. We all knew she was tapping her coworker and then calling Alex to come over and pick her up.

But he just didn’t see it. He truly believed they were just hanging out and that they were really just friends.

As I’m not one to pussyfoot around I told him repeatedly: ‘You’re trippin’ son.’

But all it accomplished was him getting pissed at me, so I eventually stayed out of it. Some people unfortunately have to learn the hard way.

The moral of this sordid little story?

Alex didn’t see what he didn’t WANT to see. His brain was pre-selecting and processing available information for proof that his wife loved him and was faithful to him.

And you already know how it all ended up not too long after. In the process Alex (hopefully) learned a painful but important lesson.

This is cognitive bias at its finest. We see what we want to see. We hear what we want to hear.

In trading this is usually deadly and so we need rules in place to keep us from destroying our trading accounts and sometimes by extension ruin ourselves.

This is why I bake lessons like these into my trading rules in order to counteract a long laundry list of cognitive biases even the best of us suffer from to varying degrees.

Let’s look at an example.

In my options trading, if I close out a loss in a particular symbol, I have a rule that prevents me from trading that symbol again for the rest of the month.

Why is that?

A while back, I was looking over my trading logs and I realized that once I took a loss in trading a symbol, it often was followed by more losses in that same symbol soon thereafter.

Whether we want to admit it or not, many of us engage in revenge trading. We are not just upset about having taken a loss. Worse yet, we get angry at a particular stock, commodity, or crypto currency for having ‘cheated us out of our money’.

Which is outright silly but that’s our monkey brain at work. I think any trader who has put in his chops has experienced a bout of revenge trading during his time.

Even the best of us who have been trading for a long time can fall prey to it. Which is why we need rules to save ourselves from our own cognitive biases.

For we have met the enemy and it’s our monkey brain 😉

Don’t be like Alex. Before you get into the game know what you are up against. And make sure the system or trading style you are adopting actually has a track record of being profitable.

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LIVE cumulative P&L of all my trades over the past year can be found here.

See you on the other side.