WHEN PEOPLE SAY “I KNEW IT ALL ALONG!”
Described in simple terms, hindsight bias is the impulse that insists: “I knew it all along!”
Once an event has elapsed, people afflicted with hindsight bias tend to perceive that the event was predictable – even if it wasn’t.
This behaviour is precipitated by the fact that actual outcomes are more readily grasped by people’s minds than the infinite array of outcomes that could have but didn’t materialize.
Therefore, people tend to overestimate the accuracy of their own predictions.
This is not to say, obviously, that people cannot make accurate predictions, merely that people may believe that they made an accurate prediction in hindsight.
This affects future forecasting, because a person subject to hindsight bias assumes that the outcome he or she ultimately observes is, in fact, the only outcome that was ever possible.
Thus, he or she underestimates the uncertainty preceding the event in question and underrates the outcomes that could have materialized but did not.
One detriment of hindsight bias is that it can prevent learning from mistakes.
People with hindsight bias connected to another psychological bias, anchoring, find it difficult to reconstruct an unbiased state of mind, simply because it leads people to exaggerate the quality of their foresight.
When hindsight-biased traders have a winning trade, they tend to rewrite their own memories to portray the positive developments as if they were predictable.
Over time, this rationale can inspire excessive risk-taking, because they believe they have superior predictive abilities.
Hindsight-biased traders also “rewrite history” when they fare poorly and block out recollections of prior, incorrect trades in order to alleviate embarrassment.
This form of self-deception, in some ways similar to cognitive dissonance, prevents traders from learning from their mistakes.
Very insightful guide on how one thinks when making decisions for trading. I didn’t know there are names for such ways of thinking.
You’re welcome! These ways of thinking are useful not just for making trading decisions, but also can be used for making any decision in life!
Hi! Maybe you can teach how do we go about using the sufficient data for evaluation and testing? Maybe you can do a guide on that?
I’m not quite sure what you mean by “using sufficient data for evaluation and testing”, could you please elaborate on that? Thanks!
I think he means how much data do you need to evaluate and do back testing?
I agree that your mind needs to be as objective and neutral during trading. It is as important as your trading skills. I am a scalper btw. So this applies even more to me.
You’re welcome! I would say staying objective is important whatever the trading style is (swing trading, scalping, trend-following, etc), but for shorter timeframes like scalping, decisions need to be made faster so it can be more challenging. Keep up the good work!
So which cognitive bias affects you the most when you are starting out?
It really depends on the personality and psyche of each individual. Different people can be “immune” to some biases, while very susceptible to other biases. If we look at the most common issues, it will probably be loss aversion and anchoring, making it hard for people to cut losses.
Appreciate your response! Yea, I am quite affected by loss aversion personally.
You’re welcome!
Is Gambler’s Fallacy considered a cognitive bias?
I pretty much think so. It stems from a lack of understanding of how probability works. The probability of one independent event does not affect the probability of another independent event.
Yes. I think A LOT of people do not really understand how probability works. I think you can cover a topic on this. It will be useful. hopefully it will be simple for layman like me.
You are welcome! Actually, we have started creating some short videos on probability on our Tik Tok channel.
Is the knowledge of probability required to trade better? I am horrible at maths.
Don’t worry, you only need a very basic knowledge of probability to understand the risk management part of trading.
What is the estimated percentage that psychology plays a part in being a great trader? I read some guides that a good trader is emotionless.
It’s really hard to give a number for this, but if I had to estimate I would say about 60-70% of trading is executing your plan with the correct psychology.
No wonder mindset covers 60% of the success of a trader!
“Win as though you were used it to, lose as if you enjoyed it for a change.” – Ralph Waldo Emerson
A perfect mindset!
Agree!
That’s right!
I agree too! It applies to daily decisions that you make everyday. Took me by surprise how many thoughts we go through daily. And I also heard defensive mechanisms. But I guess that doesn’t apply to trading.
I think loss aversion might be a psychological defense mechanism.
Hindsight Bias is probably the most common. Its supposed to be helpful though, thats how we learnt from mistakes.
That’s not true actually. Experience is how we learn from mistakes, whereas hindsight bias gives us the illusion that we would have acted differently before given the information we know have after the event has occurred. But before the event occurred, there is no way of knowing the outcome of the event.
WOULD YOU RATHER BE RIGHT, OR AVOID BEING WRONG?
So philosophical. Do you want the glass to be half empty or half full?
Do you want to make money or don’t want to lose money? 😛
Great to see that psychological topics that I learnt in uni is being applied in trading too!
How about self-fulfilling prophecy? Does it constitute as part of the trader’s mindset? If you don’t believe you can do it, you might end up sabotaging your own trades?