How Can We Avoid Behavioral Biases?

Irrational beliefs, known as behavioral biases, can unknowingly affect our cryptocurrency trading decisions. Examples of behaviors that may influence our choices include overconfidence, attempting to prevent regret by buying or selling at the wrong time, a limited attention span, and following trends blindly. To reduce the risk of making irrational choices, traders and investors should be aware of these biases and take steps to avoid them. Here are four biases and strategies for tackling them.

Introduction

Poor crypto trading and investing decisions can result from unchecked behavioral biases. Behavioral finance, which combines psychology and financial economics, studies these biases. Often unconscious, it is essential to pay attention to your behavior to minimize biased decision-making. Israeli-American psychologist Daniel Kahneman and Israeli psychologist Amos Tversky extensively researched human behavior and psychology. If you want to learn more about human biases, consider reading Judgment Under Uncertainty: Heuristics and Biases.

Overconfidence

Our tendency to believe we understand the past can give us false confidence in our ability to predict the future, according to Daniel Kahneman. This overconfidence bias is common among traders who overestimate their skills and make risky or excessive trades. Additionally, we may become overly confident in assets we have already invested heavily in, leading to a lack of diversification in our portfolio.

However, a study conducted by Columbia University’s Dr. Kai Ruggeri found that retail investors who engage in more active trading tend to make less money. Instead of constantly trading, consider investing more after conducting thorough research into the intrinsic value of a project or cryptocurrency. Diversifying your trades through research can also help to reduce the risk of holding a single token.

Avoiding Regret

Jie Qin, an economics professor at Ritsumeikan University, published a study in the Journal of Economic Theory which revealed that traders are twice as likely to sell a profitable position too early or a losing position too late in order to avoid regret. Our natural desire to avoid remorse can often lead us to make irrational decisions.

To combat this tendency, it can be helpful to follow a set of predetermined trading and investing strategies instead of making impulsive choices during market fluctuations. One way to do this is to automate your trades using conditions such as price and quantity.

One popular strategy is called dollar cost averaging (DCA), where traders invest fixed amounts at regular intervals regardless of the asset’s price.

Another option is to use a trailing stop order, which allows you to place a pre-set order at a specific percentage distance from the market price. In addition to automatically tracking price movements, trailing stop orders can help lock in profits while limiting losses, ultimately helping you avoid mistiming the market due to regret.

Trend-Chasing

A study conducted by Tulane University’s Prem C. Jain and the University of Rochester’s Joanna Shuang Wu discovered that 39% of all new capital invested in mutual funds went into the top 10% of the previous year’s best-performing funds. This tendency to chase trends rather than make logical, research-backed decisions can lead to impulsive trades.

In the unpredictable crypto market, traders may be swayed by a token’s sudden price surge and neglect to examine the fundamentals supporting this spike. Instead of blindly following the crowd, consider assets trading below what you believe is their actual value. As Warren Buffet once said, “Be fearful when others are greedy, and greedy when others are fearful.”

Additionally, you can try to refine your trading strategy and stick to it rather than jumping into every hyped-up trade. Binance Academy has numerous articles on trading strategies, including a beginner’s guide, day trading strategies, and how to backtest your strategy.

Limited Attention Span

There are numerous crypto opportunities on the market, but we can’t examine every one of them thoroughly before trading. Also, there is often a lot of noise surrounding various crypto opportunities, which can lead to misguided trading decisions. Therefore, it’s essential to thoroughly research and analyze potential trades before making a decision. Additionally, it’s wise to avoid relying on information from third-party influencers who promote crypto trading opportunities.

Closing Thoughts

To make better trading decisions, it’s essential for humans to actively monitor their behavior and strive to control their inherent biases. By doing this, we can avoid letting our instincts negatively impact our decision-making processes. In other words, by keeping our behavioral biases in check, we can reduce the likelihood of making poor decisions.