Mind Games in Trading: How to Overcome Biases and Make Better Decisions

Cognitive Biases in Trading: Anchoring, Functional Fixedness, Confirmation, and Attribution

Mind games in trading often stem from biases like the illusion of control and recency bias.
Simplicity in analysis often yields better results than complex chart setups.
Keep emotions in check by predefining trading rules.
Journaling can help identify and reduce biases over time.
Stay focused on the bigger picture rather than reacting to every market movement.

In the world of trading, cognitive biases play a significant role in shaping our decisions and outcomes. Despite having sound technical analysis and fundamental insights, traders often fall victim to these mental traps. This article explores four key biases – Anchoring Bias, Functional Fixedness, Confirmation Bias, and Attribution Bias – and how they influence trading decisions. By understanding these biases, you can improve your trading strategies and minimize the impact of emotional decision-making.

Anchoring Bias: Fixation on Initial Information

Anchoring Bias occurs when traders become fixated on the first piece of information they receive, using it as a reference point for subsequent decisions. For example, a trader might see a stock priced at ₹270 and mentally fixate on that number as the ideal buying price. Even when the price rises to ₹310, they may hesitate, convinced that the stock will retrace to ₹270.

Example: In August/September 2013, during a bear market, stocks of excellent companies were available at discounted prices. The author was keen to buy Sundaram Clayton at ₹270. However, the price moved up to ₹310, and despite solid research, he did not buy, hoping it would fall back. The result? Sundaram Clayton surged significantly, leading to one of his biggest regrets.

Lesson: The key to overcoming Anchoring Bias is to stay flexible with your price targets and not let an arbitrary figure influence your decisions. Critical thinking and a dynamic approach are essential when analyzing market trends.

Functional Fixedness: Limiting Utility of Resources

Functional Fixedness is a cognitive bias where individuals fail to see alternative uses for an object or strategy. In trading, this can mean not optimizing your available margins or sticking to conventional strategies despite having better alternatives.

Example: A trader holding a Nifty NRML position worth ₹65,000 can convert it to an MIS position to free up margins for an intraday opportunity. However, due to functional fixedness, many traders do not consider this conversion, missing out on lucrative trades.

Lesson: To overcome Functional Fixedness, practice thinking outside the box. Explore unconventional ways to manage your trades and margins.

Confirmation Bias: Seeking Supporting Evidence

Confirmation Bias makes traders selectively gather information that supports their pre-existing views while ignoring contradictory evidence. This often leads to reinforcing a flawed trading hypothesis.

Example: After analyzing Tata Motors, a trader perceives ₹430 as a strong support level. Subsequently, they interpret any positive news as a sign that the stock will rally, even if the news is irrelevant. This confirmation bias can cloud judgment and lead to misguided trades.

Lesson: Avoid forming a fixed view before collecting data. Always question your assumptions and analyze both supporting and opposing viewpoints.

Attribution Bias: Blaming External Factors

Attribution Bias occurs when traders attribute successful trades to their skills but blame external factors for losses. This mindset hinders personal growth and improvement.

Example: When a trade fails, some traders might blame the broker’s platform rather than reflecting on their flawed analysis. Conversely, when they make a profit, they credit their trading prowess.

Lesson: Maintain a trading journal to track decisions and outcomes. Reflecting on mistakes honestly fosters accountability and continuous learning.

Conclusion

Cognitive biases can significantly influence trading decisions, often leading to missed opportunities or poor outcomes. By recognizing these biases – Anchoring, Functional Fixedness, Confirmation, and Attribution – traders can make more rational decisions. Adopting critical thinking, staying flexible, and maintaining self-awareness are vital in the quest to minimize the impact of biases on trading success.

Stay aware, stay flexible, and keep learning to sharpen your trading mindset.