Understanding Trading Psychology

Anchoring bias is a tendency for people to overweight the importance of the first piece of information they have when making a decision. This can happen regardless of whether the information is relevant to the decision.

Hindsight bias is the tendency for people to believe they had predicted past events when they hadn’t. This leads to people believing they are better at prediction than they actually are.

The sunk cost trap is the tendency for people to stay committed to a course of action because they’ve already put a large amount of time or money into it. This is a fallacy because money or time already lost cannot be regained and so should not factor into decision making. It is also known as the sunk cost fallacy.

Analysis paralysis is the phenomenon where a person becomes unable to make a decision due to their inability to stop examining it. Due to the diminishing returns of additional research, analysis paralysis can cause people to lose out on opportunities for little benefit.

Herd instinct is the tendency to follow what seems to be a broadly accepted idea rather than doing your own research. Earnings forecasts are vulnerable to this phenomenon. Analysts, who are meant to be independently analyzing a company, will ensure their final predictions aren’t significantly out of line with the consensus.

Confirmation bias is the tendency for people to give more weight to information that supports what you already believe. This causes people to hold on to incorrect ideas because they undervalue information that disproves the idea.

Hot hand is the idea that succeeding in an action, such as shooting a basketball, will lead to an increased chance of success in future attempts. It was originally considered to be a fallacy, but current evidence is more mixed as to the existence of this phenomenon.