Plan Continuation #Bias And Financial #Markets

Plan Continuation Bias is a major factor driving investor losses in stock and other financial markets.  For example, many investors tend to hold on to losers for too long when they should cut their losses.  In this article, I will outline how this bias permeates our psychology by looking at how it works in air crashes, and then go on to examine its effects in financial markets. Investors will learn how to address this bias and improve trading performance.

Plan Continuation Bias, simply put, is the tendency we all have to continue on the path we have already chosen or fallen into without rigorously checking whether that is still the best idea or even advisable at all. Operating with this bias, as with the other 180+ biases that are an unavoidable feature of our psychology, is generally a good idea. We simply don’t have the time to constantly re-analyse our decisions.

Berman and Dismukes wrote a NASA report on this problem, which they describe in a brief article. They define Plan Continuation Bias as follows:

a deep-rooted tendency of individuals to continue their original plan of action even when changing circumstances require a new plan

Berman and Dismukes “Pressing the Approach” Aviation Safety World, December 2006, pp. 28–33

The authors describe two air crashes which were in their view caused by the operation of Plan Continuation Bias. Flight 1420 into Little Rock, Arkansas crashed in June 1999 because the pilots ignored alarms and persisted with an approach in difficult weather conditions. Similarly, Flight 1455 crashed in March 2000 in Burbank, California because the pilots continued with an approach even though they knew that they were flying at 182 knots which they knew was 40 knots above the target touchdown speed.

It is very easy for us to sit here on the ground and do armchair flying. We would not have made these errors we say to ourselves, wrongly. If we saw that we were flying too fast or that there were multiple alarms sounding, we would abort the landing and go around. This is not difficult to do. This quick and wrong simulation of the pilots misses out many germane factors. The pilots are under some pressure to land planes quickly and efficiently for cost reasons. There are no guarantees that going around will improve weather conditions. But ultimately, the major factor in these crashes in human cognitive bias.

Plan Continuation Bias has significant effects on the psychology of all of us. As the authors observe,

Our analysis suggests that almost all experienced pilots operating in the same environment in which the accident crews were operating, and knowing only what the accident crews knew at each moment of the flight, would be vulnerable to making similar decisions and errors

Berman and Dismukes “Pressing the Approach” Aviation Safety World, December 2006, pp. 28–33

Plan Continuation Bias is just as relevant a factor in making decisions in financial markets. We can be just as liable as the pilots described above to sticking to the plan. We bought a stock, it was a good idea at the time, and we continue to hold it even though the original reasons for it being a buy have dissipated or not transpired.

In trading, while no one is going to be killed, it is still an environment in which decisions need to be made on an inadequate data set and sometimes under time pressure. It is also going to be a highly charged situation emotionally. The inadequate data set could result from factors such as the impossibility of predicting the future or the sheer scale of the operations of a listed company. Time pressure is particularly prevalent in day trading, but even more long-term investors are susceptible to effects such as feeling that “money is burning a hole in their pocket” and they need to put a trade on right now. The emotional charge comes from losing money. We are all highly averse to losses — in fact, we seem to be 2.5x more averse to losing money than we favour gaining the same amount. It hurts to lose. It challenges our self-perception.

Photo by Snapwire on Pexels.com

These observations lead to immediate suggestions as to how one can prevent Plan Continuation Bias from impairing one’s trading psychology.

  • Try to minimise the effects of an inadequate data set by either doing more research or not trading unless you are certain or can set downside limits. Don’t take trades where it looks like you need to know everything about a company or where you think other market participants can easily know more than you. Don’t trade things you don’t understand like Bitcoin.
  • Don’t do anything under time pressure. You will need to get used to FOMO because “just getting one more trade on” will kill you quite quickly. It’s fine to miss things. It is much more important to get a small number of decisions right than to try to catch every opportunity
  • Don’t trade when feeling strong emotions and try to trade emotionlessly. This is hard to do. It is particularly hard to learn this from practice/dummy accounts. It simply doesn’t hurt very much to lose play money. You should still start here, but be prepared for real life to be much harder. Get more Zen about it. It doesn’t matter if a trade loses as long as you are up over the year.
  • Learn more in the video below:

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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