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Have you ever seen someone giving dozens of reasons for why they are right in a decision they took or are about to take?
Or, have you ever seen or heard a trader continuously justifying his view of the market for a particular trade he holds even though the trade is already in deep losses?
Well, you probably have seen this. It’s habitual for most people.
It is known as the confirmation bias in psychology.
Basically, it describes how humans make decisions that have nothing to do with rationality or objective confirmation of one’s view. On the contrary, the confirmation bias is a tendency for humans to seek confirmation of their views where there is very little of it or none.
So, rather than making a decision based on logic and actual facts, the person, in this case, believes what he wants and what he wishes to be true. The confirmation bias is nothing more than self-deception. Therefore, a strong prejudice toward one choice is present in the decision-making process which most often results in picking the wrong one.
Well, it will probably not come as a surprise that the confirmation bias is a bad companion in trading. Unfortunately, it’s heavily present among traders as well and causes them to lose money every day. Usually, this is how it goes for most traders or investors:
For example, they may like a particular investment or currency. Then, because they like that currency they tend to be systematically bullish on that currency regardless of what happens on the charts or with the fundamentals.
I see it all the time.
A trader who is bullish on USD finds all kinds of reasons for the Dollar to rise. First, it may be a bullish candlestick pattern. Once that fails, he then turns to a bullish signal on the Stochastic or the MACD – suggesting that this is the one moment when the Dollar will jump. Nonetheless, once that fails too, he starts talking about Bollinger Bands, a trendline or some other indicator giving a bullish signal on the Dollar. In the meantime, the USD has probably already fallen by 500 pips or more while this analyst is trying to find reasons to confirm his view and at the same time is blindfolded to all the other reasons for why the currency is falling.
This approach does not work in Forex trading! It’s just the confirmation bias in action which causes us to avoid looking at the reality. Essentially, it’s all false hope that is never good for a trader.
Instead, this trader or analyst is better to open his eyes widely and look at the reality of why the Dollar may be falling. Maybe the fundamentals are overwhelmingly negative for the currency or maybe a crucial technical area has been broken.
As traders and investors, we must be able to look at views that contradict our reality and challenge our views in order to improve our chances of winning.
One way we can do that is to listen and read views by other analysts which are opposite to our views. Then try to find out their reasons for why they think what they think and evaluate how strong their arguments are. How close are they to the truth compared to how close your view is to the truth? If you do a lot of this, pretty soon you will have a complete picture of the current market situation and you will be able to make better trading decisions.
So, love the trader or analyst who has a directly opposite view to your own. They will open your eyes and save you thousands of pips in trading the Forex market.
