Let’s face it, the stock market is a dangerous place.
One week you have Jerome Powell threatening to bring down the hammer, the next you have a string of earnings misses…
These pale in comparison though to the mental dangers that impact traders, day in and day out.
Confirmation bias is one of the least talked about ones…
Yet, it’s also one of the most dangerous!
What is confirmation bias?
It is people’s tendency to process things using information that is consistent with their existing beliefs.
Folks often have a hard time figuring out how this concept relates to trading.
Here’s the reality…
Trading is not astrophysics.
It’s as much of an art as it is a science!
While this isn’t bad, it does mean that it is much easier for traders to filter things based on what they want to believe.
Example?
When folks have a string of wins in a row, it is common for them to start believing that they have some sort of newly acquired ability to turn anything they touch into gold.
The problem is they start operating from that assumption…
They will unknowingly exclude negative information regarding a trade and focus solely on the positives.
Why is this bad?
It often leads to foolishly large position sizes, bad entries, and a lack of risk management altogether!
So what’s the solution?
1.) Awareness
As basic as it sounds, you first have to be aware of what’s happening…
It’s very difficult to negate confirmation base if it’s operating in the shadows!
Once you bring it out in the light and accept there’s a problem…..finding a solution becomes much easier.
Of course, it’s not as simple as that…
The mind is tricky and trading is very complex.
We need actual tools in our toolkit in order to identify and combat the problem.
2.) Have a plan
This is where having a plan comes into play.
In order to know that your trading is veering off course via confirmation bias, you need to know in what direction the ship was heading in the first place…
You need to be specific though!
How large of a position size are you willing to take?
What confirmation signals are you looking for before entering a position?
While a plan won’t necessarily prevent confirmation bias from seeping into your trading, it will make it much easier to identify when it is present!
3.) Keep a trading journal
Everything we’ve talked about up until this point is all well and good, but what do we actually do when we find ourselves making illogical trading decisions due to confirmation bias?
The answer…
Have a trading journal at your side to keep track of what’s happening during a trade.
If you do something great…..record it.
When you screw up…..write that down too.
I don’t mean just the technical and fundamental details either!
It’s important to record the trading process with as much detail as possible including the emotions.
In other words, why you made the decision that you made at that moment…
While it may not seem super helpful at first, it is important to keep doing it.
Over time you will identify invaluable patterns that will help you navigate your confirmation biases during trading much better.
4.) Walk Away
When all else fails, the single most powerful way to break the trend of confirmation bias is to simply stop trading!
Why?
Because it is heavily influenced by strong emotional states…
Come back to it in a day, a week, or however long it takes to bring your emotions back to neutral.
While this can be a tough pill to swallow, believe me…
You will thank yourself for doing it!
That’s all for now…
Until Next Time,
-Damian