Many cognitive biases affect our trading performance. One of them is Attentional Bias. I will describe what it does and explain how it affects your trades.
Are happy people better at picking up information that will make them happy? Do sad people do the opposite? Have you wondered how your mood can affect your behaviour
in ways you don’t know about? All of this is true and can be explained by considering one form of a Cognitive Bias called Attentional Bias.
We are subject to approximately 150 Cognitive Biases, at the last count. All of them affect our thinking without us necessarily knowing too much about when they are at work or what the results are. My project initially is to list and describe these mental subroutines before critically examining them and assessing how they work in a market environment. The objective is to allow market participants to look out for the operation of Cognitive Biases in their own thinking and trade on the expectation that they will also figure prominently in the thinking of other players.
What is Attentional Bias?
One of the most important Cognitive Biases is Attentional Bias. It comes in several forms, but all of them have in common that they systematically slant which information we pay attention to. Obviously this has dramatic effects on thinking and market outcomes. In this post, I will first describe Attentional Bias and then outline how it might play out in a market setting.
Much of the psychological literature on Attentional Bias looks at what we can term mood congruency. The basic idea here is that we are more likely to look at information which fits our mood. So, anxious subjects are more likely to look at anxiety-inducing information and depressed subjects are more likely to consider depressing information. Clearly this is already rather unhelpful for such subjects, but my aims here are only to look at what this might do in markets.
Depression as an Example
This is widely important because generalised anxiety affects a significant proportion (estimated at between 5% and 30%) of the population. This is people who are more-or-less anxious more-or-less all of the time. Since it is a significant minority, it is likely that some of these subjects participate in financial markets, although it is possible that some anxious individuals will self-select out of stock markets.
Depression of sufficient gravity to merit a psychiatric diagnosis affects about 1% of the population; many more people will experience a less severe depression or a more episodic form. Again, we can expect plenty of depressed market participants to be trading.
Experimental Data on Attentional Bias
Experimental investigations of mood-disorder linked Attentional Biases have focused on reaction time studies. A pair of words was briefly presented to experimental subjects on a computer screen. Sometimes, one of the words was replaced with a dot, which was the signal that a button should be pressed. The experimenters record the time it took for subjects to press the button. It would typically be in the range of several hundred milliseconds.
Sometimes, the other word presented on the other side of the screen to the dot was a threatening word. The word could be socially threatening (‘humiliated’) or physically threatening (‘injury.’) The experimenters found an RT spike. That’s what psychologists call a delay in reaction time. People took longer to see and react to the dot if a threatening word appeared on the other side of the screen. These effects were quite large.
Perhaps most interestingly, the RT spikes were larger for anxious or depressed subjects, especially if the threat word was specifically related to either anxiety or depression.
What Effects Of Attentional Bias Should Such Individuals Be Aware Of?
It is obvious that such effects could impair traders on a trading floor who are making rapid trade decisions themselves. Information near their field of vision which is threatening — such as a negative Bloomberg headline — could grab the trader’s attention and cause a delay in response time even if it is unrelated to the trade under consideration at the time.
While this is a real issue, I want to consider non-professional traders as well. In general, you should avoid day-trading. 85% of day traders lose money.
Day-trading is popular among people new to investing. The aim is to minimise risk by not holding any positions over-night. However, the necessarily short-term nature of this approach means that one can really only benefit from ‘noise’ in stock movements and there is no way to rationally forecast noise. Relying on luck is even worse in markets than elsewhere because the punishment is swift. It is better to be a buy-and-hold investor.
Don’t Trade Depressed — or in Any Strong Emotional State
If you are depressed or anxious, don’t trade. It is almost always better to do nothing.
Negative mood-congruent information will grab attentional resources and make traders much more likely to exit positions. This may or may not be the right decision to make. You should make such a decision rationally and with a fair and open consideration of the relevant data. Often this will not be what everyone else is doing, so my approach lends itself naturally to a contrarian investment stance. There are other good reasons to be a contrarian investor, including that it fits with a long-term approach — so it is not something much engaged in by day-traders.
If you are permanently depressed or anxious, then you should get treatment. Abstain from trading until you see an improvement. If you can’t improve, then I am sympathetic, but I would suggest hiring financial advisers in that circumstance. It would be one thing less to be concerned about and would likely have more optimal outcomes, despite the extra fees involved.