· To recognise the types of emotional biases when trading or investing in cryptocurrency.
· To understand how biases can influence and distract one from impartial decision-making.
· To identify how one can disregard biased inaccuracies, to improve trading and investment practices moving forward.
The 2017 cryptocurrency bull market created hype and hysteria of somewhat epic proportions, which was ultimately the downfall of several of aspiring traders and investors. People became overcome with emotional bias preventing them from engaging with the rational thought of what going to happen next, instead following direction on what they wanted to happen next.
The traits displayed above have become prominent yet again over the last couple of months. The value of Bitcoin has increased from a bottom value of $3,200 per coin to around $9,000 per coin, posting higher lows in the process. This bullish uptrend has caused some aspiring traders to fight the trend and try to short potential tops, while others have ensued panic at every dip, instead of buying. The bear market has proven to become engrained within some cryptocurrency participants, and this emotional bias is again being magnified by a shift in the market.
It is unfortunate for some, that markets do not consider one’s feelings and they will not behave in accordance to suit one’s desires. It is up to the aspiring trader or investor to adjust to changes in the market and to not resist changes.
This article will aim to address such difficulties and look to investigate how bias can be managed in both cryptocurrency trading and investing.
The term “bias” is not a new concept when it comes to trading and in this instance can be reasonably defined as “having an irrational preference or prejudice”. In order for one to secure judgement on an optimal trade or investment, there needs to be an awareness of these biases.
Aspiring traders and investors can understand the mechanics of trading strategies directly from literature, in a relatively moderate amount of time. This can create a false sense of security that they are ready to take on any market. This is not the case. The application of such trading strategies is the typical stage where aspiring traders or investors do not meet their expectations. There can be a lack of emotional understanding, which leads to mental shortcuts interfering with one’s goals. These cognitive biases can include:
Loss Aversion (also known as Prospect Theory) refers to the trader’s or investor’s tendency of preferring to avoid losses over acquiring equal gains. If we apply this to Bitcoin’s aforementioned bullish movement, the trader in this example would be fearing losing a nominal amount, more than securing it in profit. Sound familiar?
Source: Devon Hennig
Psychologically studies over the years have shown that losses are absorbed more tellingly than gains. The result of this is psychologically, the trader or investor, will side with avoidance of loss, even if odds are equal or sometimes better for the same amount in profit.
The risk tolerance of one individual to another varies, though it is worth asking yourself, “what odds would you require to make an investment / trade decision in your favour?”. This should bring some realisation to how you are measured on the loss aversion scale.
Hindsight Bias (also known as Lookback Tendency) refers to the predisposition of revisiting an event to review if it was predictable, even though there was no objective basis to foresee it. This can be recognised in the cryptocurrency world, especially on the social media platform Twitter, as many aspiring traders can be seen speaking in hindsight on sharp market movements that is sometimes not possible to determine.
An example of the above could be a trader or investors retweeting one of their previous vague tweets, to try to make it appear that they correctly called the exchange listing of altcoin. This example usually provides the coins value to rapidly increases in a short period of time.
Recency Bias is supposing recent past events will continue to transpire in the future. It is these recent past events that are fully consumed by the aspiring trader to continue to play out in the future. This was particularly identifiable when Bitcoin found bottom value of $3,200 per coin and aspiring traders had already become married to their recency bias that Bitcoin would continue to drop, and fought the bullish uptrend, in some cases, all the way up to $9,000 per coin.
The diagram below offers a visual depiction on how the “rollercoaster of emotions” can affect trading or investing in various stages of a market.
Source: Colorado Financial Management
Anchoring Bias describes the human tendency to become too trusting in the first piece of offered information (in the decision-making process), known as the “anchor”. This tendency leans to the bias of processing information sequentially and basing future outcomes on information that has been initially received. There is a variety of ways that this could be interrupted in the world of cryptocurrency. This could be the confusion of FUD (fear, uncertainty, doubt) news with fundamental news that actually has relevance to a project’s development.
The diagram below depicts how this illusion can be created.
Source: Anchor Banker
A noticeable example includes the free fall of Bitcoin from $6,000 per coin to $3,200 per coin. There were significant panicking thoughts that ensued in some aspiring traders and investors that Bitcoin was heading for a total collapse to $0 per coin, due to a hard fork occurrence in Bitcoin Cash that created both Bitcoin SV and Bitcoin ABC. A greater emphasis was placed on this news by some aspiring traders and investors, which prevented them from recognising that the market was capitulating to find a bottom. This subsequently caused enough uncertainty that some will have not bought at this lower end of the market cycle. The aspiring trader and investor may have considered the negative news rather than the positive opportunity.
Confirmation bias is acquirement of information that supports an aspiring trader’s or investor’s initial opinion, along with disregarding all other sources. Confirmation bias in trading parlance, will see a trader enter a trade while being blinkered by evidence that only reinforces their own thesis. There are many examples of this in cryptocurrency trading, however some of the most prevalent instances are usually when traders / investors are solely “committed” to one specific altcoin. This can cause the trader / investor to ignore key price factors such as market trends or negative developments in that specific altcoin, due to their unshakeable attitude towards it. The end result can be an altcoin is held onto for too long and consequently it can decrease drastically in value. Typically, this can be very avoidable, though these examples remain common occurrences in cryptocurrency, especially in the altcoins with “cult-like” communities.
To allow your approach to be objective, it is imperative to have a cognitive awareness when considering opposing standpoints of a trade or investment. If important information is being overlooked that does not match a biased personal opinion, it is likely that confirmation bias has overtaken an impartial decision in being made. History has actually shown us that the some of the most distinguished traders and investors have a penchant to find disconfirming evidence, in order to tighten up their own trading and investing strategy.
The skill of being able to recognise and overcome one’s trading or investing bias may not be a simple task. It requires an inner truthfulness that could unpick a previous belief system, in order to face up on past failings.
If one of the above biases is a fitting reminder of past trades or investments, this will also allow some realisation that previous practices have been carried out upon clouded judgement. Revisiting these events could become uncomfortable, but necessary. This awareness will allow for the backtesting of the previous failings, in order to gauge how they were aligned with a personal bias at that time. This should provide some developmental assistance for improving decision making on future trades or investments.
“A man must know himself thoroughly if he is going to make a good job out of trading”.
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