Cognitive Biases And How They Affect Stock Markets

There are an extraordinarily large number of cognitive biases which change the way we think — it is important to know about these in stock markets both in order to look for them in one’s own thinking and expect them in that of other market participants

A Cognitive Bias is an element in our psychology which makes decisions for us.  In fact, given there are so many of them, you might even say that our psychology is just Cognitive Biases.  I discuss about 20 of them and give market context in my new book:

One example which I discussed in a previous post is Hindsight Bias.  This makes us think that everything which has happened was inevitable.  This in turn makes us very bad at knowing what level of probability we assigned to past events.   We seem to remember that we said that a prior event was going to occur with 90% probability when in fact, we gave it a probability of 30% before that event occurred.  This will obviously have unhelpful effects in the context of markets.  It will make us greatly overestimate our chances of knowing what is going to happen next, which may make us trade with over-confidence.  There is nothing quite like over-confidence to kill market performance.

As I said, the book covers around 20 biases and their effects in markets in much more detail than I can give above.  The thing is though, that there are way more biases than that.  In fact, from the chart below, which is due to Bence Nanay, you can see just how many there are.

Every one of these biases will affect your market thinking and that of everyone else involved.  So it looks like we all have some work to do!

See Also:

#Narcissism and #Unexpected Behaviour

The Illusory Truth Effect And Financial Markets

If You Like Gin And Marmite, You Are Probably A Better Trader

The Late Evaluation Effect And Financial Markets

The #Bitcoin Bubble Is Caused By The Halo Effect

The #Anecdotal Fallacy And The #Bitcoin Bubble

The Picture Superiority Effect And Financial Markets

Negativity Bias And Financial Markets

In Financial Markets, Relying on the “Wisdom of Crowds” Can Be Very Risky

Attentional Biases And Financial Markets

83% of Millennials Regret How They Handle Their Finances: Why?

The Importance Of Hindsight Bias In Financial Markets

Kerviel: The SocGen Rogue Trader And What Is Surprising About How He Got Away With It


Author: Tim Short

I am a former investment banking and securitisation specialist, having spent nearly a decade on the trading floor of several international investment banks. Throughout my career, I worked closely with syndicate/traders in order to establish the types of paper which would trade well and gained significant and broad experience in financial markets. Many people have trading experience similar to the above. What marks me out is what I did next. I decided to pursue my interest in philosophy at Doctoral level, specialising in the psychology of how we predict and explain the behaviour of others, and in particular, the errors or biases we are prone to in that process. I have used my experience to write The Psychology of Successful Trading. In this book, I combine the above experience and knowledge to show how biases can lead to inaccurate predictions of the behaviour of other market participants, and how remedying those biases can lead to better predictions and major profits. Learn more on the About Me page.

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