Even after trading for around seven eight years, I still fall for some of these pesky traps because the human brain is pretty stupid. But after learning about them, I have gotten much better at identifying when my brain is about to fall for a psychological trap.
Since around 60% of trading success is based on your trading psychology, just understanding these psychological trading traps has made a huge improvement in my trading performance. In fact, I would argue that it’s one of the main reasons I stopped losing money consistently in trading.
Number 1. You buy a stock, and the price makes a good move in the upward direction. So you book a profit and are very happy. But then the price moves upward even stronger. This makes you regret booking the profit. You think that you made a mistake exiting the trade early. Based on the bad experience you got from this trade, you decide to aim for way bigger profits on future trades.
This is actually a psychological trap known as Hindsight Bias. You are making the mistake of using present data to agree or disagree with past decisions, even though those past decisions were correct according to the data available at that time.
I have also seen beginner traders feel frustrated when the price triggers their stop-loss but then reverses strongly in the entry direction. They believe the stop-loss was too tight, even though it was at a reasonable level. That’s still making decisions in Hindsight.
The easiest way to avoid falling for this trap is to avoid changing your strategy rule after each trade. It is better to use data from 100 or more trades to see patterns and make decisions.
Number 2. After a series of losing trades, if you think the next trade has a higher chance of winning because you can’t continuously keep losing, then it’s a trap known as Gambler’s Fallacy.
I’m pretty sure I have fallen for this trap in my early trading days.
If you believe that after winning for multiple days in a row, you are going to get multiple losing trades, then that’s wrong thinking as well.
A coin toss is a good example of this. If you flip a normal coin, we all know it will have a 50% chance of landing on heads. But if you get 10 tails in a row, the next coin flip will still have a 50% chance of landing on heads.
Number 3. This psychological trap can be less obvious, but it can make you lose big amounts of money. If you ever find yourself fixated on a particular price level or a support area, and are ignoring everything else, then that is known as an Anchoring Bias.
If you are holding onto a losing stock position because you don’t want to sell below the price you bought it at, then it’s Anchoring Bias as well. You are focusing too much on one piece of information, like the price you paid for a stock, and using that to make future decisions.
A better but difficult thing to do is admit when you’re wrong and cut your losses early, rather than hoping the stock will recover to your entry price.
Number 4.
Imagine you’re scrolling through Reddit, and suddenly, everyone and their grandma is talking about this new stock that’s supposed to be hotter than the sun. Without doing any research, you’re like, “Shut up and take my money!” and smash that buy button. I mean, if many internet people say it’s a good investment, it must be true, right?
Congratulations, you’ve just fallen into the Herd Mentality trap! Just because a stock is trending on social media doesn’t mean it’s going to the moon. I mean, some stocks do go to the moon, but most of them don’t.
Number 5.
Imagine you’ve been studying a stock like it’s your favorite Netflix series, and you’re absolutely convinced it’s about to blast off to the moon again. You start searching the web for any shred of evidence that confirms your brilliant thesis, while ignoring anything that suggests otherwise. Red flags? What red flags? You’re too busy picking out the color of your future yacht to notice!
Well, well, well, you have just fallen for the Confirmation Bias trap! This sneaky little devil can make you chase trades that are really, really dumb. If you want to become a profitable trader, be willing to change your trading opinions if the evidence isn’t in your favor.
Number 6.
Imagine a stock falling really, really fast. You’re watching the chart, and all you can see is red candles piling up. You’re thinking, “This is it! It’s time to short this sucker and ride it all the way to the bottom!” But you fail to see that the stock has been in a strong uptrend for the last year. This recent downward move was just a small pullback. It was not the time to sell; it was time to buy.
You have just fallen for the trap known as Recency Bias, the nearsighted grandpa of the trading world! This mental trap makes you focus more on the recent events than the bigger long term picture.
Number 7.
Imagine you’ve been trading for a while now and have developed a strategy that you believe is foolproof. You’ve had a few big wins using this method, and you’re convinced that you’ve cracked the code to consistent profits.
One day, you’re chatting with a fellow trader who asks about your strategy. As you explain your approach, they point out a few potential flaws and risks that you hadn’t considered. They even share some examples of how a similar strategy has backfired on other traders they know.
Instead of taking their feedback to heart, you find yourself getting defensive. “They just don’t understand my strategy,” you think to yourself. “They’re probably just jealous of my success.”
You continue to use your “foolproof” method, convinced that your friend is just being overly cautious. However, you start to experience more and more losses. You struggle to adapt your approach, but you’re so convinced of its effectiveness that you can’t bring yourself to admit that it might be flawed.
Congrats, you’ve just fallen for the Blind Spot Bias. This sneaky trap makes you see faults and bad decisions in others, but not in yourself. It’s like pointing out your friend’s messy room while ignoring the fact that yours looks like a tornado hit it.
Number 8.
Imagine you were a fundamental only trader in the old days, but now your old strategies are not working. You see people using new technical methods and make huge profits. Even though your strategy is not working, you still stick with it and lose most of the account.
You just fell for the Status Quo Bias, the enemy of adaptability! This mental trap makes you resist change, even when it’s clear that your current course of action isn’t working. It’s like refusing to get a new phone because you’re used to your old flip phone from 2005. The market is always changing, and what worked yesterday may not work today.
Number 9.
Imagine you’re researching a stock, and you come across a report from a well-known analyst. The report is glowing, full of positive projections and buy recommendations. You think, “Well, if an expert says it’s a good buy, it must be!” You go all-in, only to watch the stock plummet the next day.
This is known as the Authority Bias, the poison of independent thinking! This cognitive trap makes you put too much faith in the opinions of experts and authority figures, even when they might be wrong.
It’s like believing everything your older sibling told you as a kid, just because they were a few years older. Remember, even the most respected analysts can be wrong sometimes. Better to take expert opinions with a grain of salt.
Number 10.
Imagine you’re watching a financial news channel, and the anchor starts talking about a hot new stock. “This company is going to change the world!” they say, as images of rocket ships and piles of cash flash on the screen. You think, “I better get in on this before it’s too late!” You buy in at the peak of the hype, only to watch the stock crash and burn.
That’s the Framing Bias in action! This cognitive trap makes you react differently to the same information, depending on how it’s presented. It’s like saying the price of a phone is too high, then getting excited when a 50% off sticker is applied next to the exact same price.
Number 11.
Imagine you have bought a stock like Apple, that has been going up for years. You start to feel a sense of attachment to the stock. You start thinking of it as “your baby,” and you can’t bear the thought of selling it. Even when the price starts to fall, you hold on tight, convinced that it will bounce back. Before you know it, your once-profitable trade has turned into a losing one.
Say hello to the Endowment Effect, the emotional baggage of the trading world! This cognitive bias makes you place a higher value on things that you own, simply because they’re yours. It’s like refusing to sell your old, beat-up car because of all the memories you have with it. Always be willing to sell when the time is right, and don’t let emotional attachments turn into losses.
Number 12.
Imagine you’re scrolling through a list of stocks, and you see a company that you know and love. Maybe it’s your favorite fast-food chain or the company that makes your go-to toothpaste. You’re like, “I know this brand! I’m gonna invest in it!” So you go all-in, convinced that your loyalty as a customer will translate into profits.
Fast forward a few months, and your portfolio is not looking diversified enough. You’ve got all your eggs in one basket, and that basket is starting to look a little wobbly.
Say hello to the Familiarity Bias! This mental trap makes you invest in things you know and understand, even if it means taking on more risk. It’s like eating at the same restaurant every day because you’re too scared to try something new. To avoid this trap, it’s better to branch out and diversify your portfolio. Don’t let your love for a particular brand blind you to the benefits of spreading your bets!
Number 13.
Imagine you’re watching the news, and you see a story about a company that’s just had a massive data breach. You start to panic, thinking, “Oh no, this could happen to any company! I better sell all my tech stocks before it’s too late!” You make a quick decision based on one event, without considering the bigger picture.
Congratulations, you’ve just fallen for the Availability Heuristic! This mental shortcut makes you overestimate the likelihood of events that are easily remembered or recently experienced. It’s like assuming that every dog is dangerous because you got bitten by one as a kid. To avoid this trap, take a step back and look at the long-term data.
Number 14. The Restraint Bias:
Imagine you’re on a strict trading diet. You’ve got your plan all laid out, and you’re determined to stick to it like glue. You’re like, “I’m gonna be disciplined! No more impulsive trades for me!” But then, you see a stock that’s moving faster than Usain Bolt on Red Bull. Suddenly, your discipline goes out the window. You’re like, “Just one little trade won’t hurt, right?” Before you know it, you’ve blown past your risk limits.
Say hello to the Restraint Bias, the diet-buster of the trading world! This mental trap makes you overestimate your ability to control your impulsive behaviors, leading you to move away from your carefully crafted trading plans. Using a simple checklist has helped me avoid this trap in my beginner trading days. Or maybe you can have a trading buddy who can slap some sense into you when you start to break the rules!
Number 15.
Imagine that you just made a few winning trades, and suddenly, you’re feeling like the Wolf of Wall Street. You start thinking, “I’m very good at this! I finally became profitable!” So, you start making bigger and riskier trades, convinced that your winning streak will never end.
Whoa there, cowboy! You’ve just fallen into the Overconfidence Bias trap. Even the best traders have losing streaks. Don’t let a few wins inflate your ego and cloud your judgment. Stick to your risk management rules, no matter how many times you’ve won in the past.
Number 16.
Imagine you’ve had some bad trades, and now you’re scared to make any moves, like a kid who’s afraid of the dark after watching a scary movie. Even when a golden opportunity presents itself, you just can’t pull the trigger. You’re like, “Nah, I’ll pass. I don’t want to risk it!”
This is Risk Aversion. While it’s smart to be cautious, being too scared to take any risks can make you miss out on some serious profits. It’s like being afraid to ask your crush out because you got rejected once in middle school. Don’t let past losses paralyze you.
Number 17.
Imagine you just won an awesome trade, and you’re feeling like a Wall Street wizard. You start thinking, “It was all me! My skills are unmatched!” But last week, when you lost big on a stupid impulse trade, you blamed the market and big banks for moving the price toward your stop-loss.
You just fell for the Self-Serving Bias! This mental trap makes you take all the credit for your wins, but blame external factors for your losses. It’s like a football player who celebrates every goal but blames the referee for every bad decision.
Number 18.
Imagine you’ve been investing money into a fund for many years. So far, the fund is underperforming the stock market index returns. Maybe it’s even making a loss. But instead of moving the investment amount into better things, you decide to keep everything the same because you have spent so much time on it.
This is the Sunk Cost Fallacy. This mental trap makes you keep throwing good money on bad things, just because you’ve already invested a lot. Sometimes, the best thing you can do is cut your losses and move on.
Number 19.
Imagine you’re watching a stock chart, and you notice a weird pattern. It looks like a rubber duck wearing a top hat! You convince yourself that this “Top Hat Duck” pattern is a sure sign that the stock is about to explode. You go all-in, already planning your early retirement. Fast forward a week, you have lost money and are crying in the corner.
You have fallen for the Clustering Illusion bias! This cognitive trap makes you see patterns and trends where none really exist, like seeing shapes in the clouds. Just because a chart looks like your favorite cartoon character doesn’t mean it’s a cosmic sign to buy.
Number 20.
Imagine you won multiple trades left and right, convinced that you’re the master of the market. You’re like, “I’ve got this! I can predict every move before it happens!” But then, reality hits you like a ton of bricks. You make a big loss and realize that the market doesn’t care about your feelings or your ego.
Welcome to the Illusion of Control! This cognitive trap makes you overestimate your ability to control or predict market outcomes, leading to overtrading or excessive risk-taking. It’s like thinking you can control the weather by doing a rain dance.
Number 21.
Imagine you’re holding onto a stock that’s been going up like a rocket. You’re so excited that you start counting your profits before you even sell. You’re like, “I’m gonna sell this baby and buy that new iPhone!” But then, suddenly, the stock starts to dip a little. You panic and sell it faster than the speed of light.
Meanwhile, you’ve got another stock that’s been falling like a rock. But instead of cutting your losses, you hold onto it like a bad habit. Before you know it, your once-promising stock has turned into a dumpster fire.
Congrats, you’ve just been hit by the Disposition Effect! This mental trap makes you sell your winners too early and hold onto your losers too long. It’s like being a gambler who cashes out after a small win but keeps playing until they’re broke. To avoid this trap, set clear profit targets and stop-losses, and stick to them no matter what! This is, of course, easier said than done. But you have got to try if you want to be profitable!
Now watch this video next to see some of the Best Trading Strategies I have Used in around seven eight years of my trading journey.
