As a trader, you are highly aware that the lucrative and volatile cryptocurrency industry requires a lot of discernment. Even though crypto has been around for a decade, it’s still a relatively new player in the market—especially when it comes to the financial aspect.
At the center of wealth creation arises the same goals of making the right moves and earning a profit. As such, people test out tons of financial strategies to get ahead. But sometimes, these “power moves” could prove to be detrimental to your assets, since common cognitive biases may heavily influence these actions.
What Do Cognitive Biases Have to Do with Trading?
When it comes to trading, cognitive computing and decision-making are of utmost importance. There are a ton of biases and social conditioning that can impact the way you plan and execute your next move, and most of the time, you’re not aware of this. These biases can hinder you from thinking objectively and making the best possible strategy for your assets. The information could be all laid down for you to study, but your mind could tell you to go a different direction anyway.
Awareness of these biases can help you spot when you’re making the same kind of thinking, and even identify the times you’ve done it before. In the infographic and discussion below, we’ll touch on the most common cognitive biases in crypto trading.
Tip: Click to open the full infographic in a new tab
The Most Common Cognitive Biases in Crypto Trading
1. Anchoring Bias
You probably still remember the news that Bitcoin is the most influential cryptocurrency in the world. As it stands, this statement is true, but that doesn’t always necessarily mean a good thing in the overall crypto trading world. Bitcoin has surfed through tremendous highs and lows during its ten-year lifespan, and it’s still highly unpredictable to date. However, you probably only remember its power, popularity, and high returns.
To illustrate the point of this cognitive bias, the first price of a new token you see today may be your anchoring piece of information. After that, you consider prices to go up or down based on that initial price. So, if prices go lower than the anchor price point, you believe you missed your chance, and it’s challenging to adjust your perception or expectations about its projections in the future.
2. Authority Bias
Getting involved with crypto trading means continually checking the trends on various online media outlets and hanging on every last expert’s word about the so-called future of cryptocurrency, along with the bullish or bearish fate of any tokens you’re holding. The danger here lies when you develop a false sense of security in these experts and start to believe that everything they say is right.
As a crypto trader, you should be able to form your strategies and techniques only with inspiration from the experts you took advice from. Crypto is a vast jungle, which means there is more than one way to develop best practices. These thought leaders may have the upper hand, but they don’t know it all.
To find out if authority bias is heavily influencing your trading decisions, look at your most recent trades and ask yourself why you made them. If you can’t give yourself a logical explanation other than “because Influencer X said so,” then you’re just following what’s been said and done before without understanding the concepts behind it.
3. Availability Heuristic
This bias is more of a mental shortcut. It’s when you make a judgment or prediction about a topic based on information that is readily available about said phenomena.
For instance, you could’ve recently checked the news or social media about the bullish trends of Bitcoin. Since Bitcoin is such a heavily advertised currency, there are new reports about it almost every day, usually following a lengthy ongoing discussion about the topic. If you only rely on the most recent information you saw without digging up for information yourself, you’re becoming a victim of the availability heuristic.
This cognitive bias gave birth to the “Do Your Own Research” movement, which encourages people to search for information that lies out of reach more than what’s blatantly available.
4. Bandwagon Effect
The more people do it, the more it must be right.
Cryptocurrency can be considered as part of one giant bandwagon effect, especially when Bitcoin was first introduced in the market. People were buying the virtual tokens without fully realizing what it is or what it could signify for them in the future, just because many people were doing it or because cryptocurrency was “cool.”
Fast forward to today, this bandwagon effect is still felt and seen during bullish trends in the market. This so-called herd mentality increases the probability of a trader to adopt the belief of other traders who hold a particular view, such as purchasing a certain amount of altcoins or at a certain period, even if facts or previous trends don’t support these actions.
5. Confirmation Bias
The confirmation bias is pretty stealthy, and most people don’t notice that they’re victims of this kind of thinking until it’s too late. It refers to the tendency to search for evidence that proves what we already know as correct. It’s almost like looking for facts that can support your argument in a debate. While you can spot a gold mine of relevant information, there’s a considerable chance that you’re not going to be looking at the bigger picture.
The news, trends, and sources surrounding the world of cryptocurrencies and crypto trading are quite overwhelming. They flow in real time, and trends come and go. It’s easy to be selective with the information that you want to see or believe, especially in such a new and frenzied industry.
6. Loss Aversion
People generally want to avoid the feelings of loss, even when presented with an opportunity for equal gain. Getting a new car doesn’t feel as amazing as it would be devastating to lose a car. If you experience loss aversion, then you’re probably doing actions that put you on the path of avoiding losses rather than actively seeking for gains.
In the crypto trading world, loss aversion can be triggered if you see that the value of your money is dropping. This could cause you to jump ship and sell too early without waiting for trends or further studies that could explain the phenomenon. Giving in to these feelings would only be warranted if you find evidence that the token is lofty or a scam, for instance. Being ruled by your emotions can sometimes be your biggest problem.
7. Optimism Bias
While there’s nothing entirely wrong with being optimistic about your general outlook in life, too much of this can be a bad thing when it comes to making wise trading decisions. If you look at it from a different perspective, you can link optimism with overconfidence.
Say, you’ve had a winning streak lately, or have not suffered significant losses. It’s important to remember that this is attributed to your knowledge of trading rather than blind luck. A winning streak will not guarantee that any of your next moves will bring something positive.
On the other hand, after enjoying too many wins, there’s a tendency to feel lax and act on a whim when trading. Cryptocurrency is volatile, and not every token will multiply in thousands of ROI, despite your positive mojo.
While there’s generally no concrete way to “stop” cognitive biases from occurring, the first step to regaining control over your trading decisions is awareness that you are a victim to some of these thinking patterns. Humans are heavily influenced by social behavior and emotions, but if you want to make better trading decisions, then you should learn to disidentify from them so you can be as objective as possible.