24 Trader Decision Making
& Cognitive Biases
1. The Disposition Effect: The tendency to cut winners too short and let losing trades run (Loss Aversion), yielding negative expectancy.
2. Looking for No's: Approaching trades by attempting to find something that could work versus searching for what is objectively optimal.
3. Strong Convictions Loosely Held: Bayesian analysis with quantitatively supported ideas that are regularly updated based on new evidence.
4. High Win Rate Emphasis: Misunderstanding that high win rates can still have negative expected value.
5. "You Can't Go Broke Taking Profits": You can go broke taking profits too quickly if the losses, when realized, are large enough (see Disposition Effect).
6. Goldilocks Analysis: Overweighing optimal outcomes and not fully appreciating non-conforming outcomes seriously enough.
7. Skill Gap Analysis: Misjudging the level of skill required to be successful at something and/or overestimating our skill level (think "there are levels to this" concept).
8. Confirmation Bias: Weighting information that adheres to existing beliefs versus pursuing objective reality.
9. Anchoring Bias: Overweighing reference points and becoming attached to a perspective.
10. Hindsight Bias: Falsely perceiving past events as being more predictable than they actually were.
11. Survivorship Bias: Sample selection bias focusing on successful samples as representative of the entire population.
12. Overconfidence Bias: Part of the Dunning-Kruger Effect, where we overestimate our abilities and/or how much effort we put forth.
13. Blindspot Bias: The perception of being less biased than other people and the proclivity to assess others' bias as more severe.
14. Outcome Bias: Evaluation error of a decision cycle when the outcome is already known, which skews our analysis.
15. Availability Heuristic: Mental shortcut where immediately available data points are overweighted.
16. Sunk Cost Fallacy: Reluctance to abandon a course of action because of a previous investment in it.
17. Illusion of Control: Overestimation of one's ability to control events or outcomes.
18. FOMO (Fear of Missing Out): Fear of missing out, leading to impulsive decision-making without rigorous analysis.
19. Gambler's Fallacy: Incorrect probabilistic weighing of a future outcome based on previous occurrences.
20. Hasty Generalization: Conclusions drawn from insufficient data or generalizing inadequate samples.
21. Cognitive Bias: Over-filtering of information through a personal lens, losing an objective view of the data.
22. Recency Bias: Overweighing more recent information and devaluing older data points.
23. Reductive Bias: Oversimplification of a process and/or it's corresponding inputs and failure to objectively analyze things holistically.
24. Cognitive Dissonance: When a person fails to objectively evaluate something and develops a cognitive gap between what they believe reality is and what reality actually is.
The Dunning-Kruger Effect
The Dunning-Kruger effect is a cognitive bias those with low ability, knowledge, or expertise tend to overestimate their own skill level, while those with high ability, knowledge, or expertise tend to underestimate their relative competence.
I had been trading for several years, studied for hundreds of hours, and made thousands of trades. Yet, I ended up experience the largest % drawdown of my trading career precisely at this point.
What happened? The Skill Gap Peak. The Dunning-Kruger effect is a MUST KNOW concept for traders (or people building any skill). There's a delicate period of time where we know just enough to hurt ourselves and are ripe for our own destruction.
