CONVENTIONAL THINKING SUGGESTS that the best decisions are the unbiased ones. But the fact is that we’re genetically rigged to make assumptions. We didn’t come out of the womb ready to operate as adults. Knowledge is learned, and our opinions on everything from sex to Cisco (CSCO) are simply the sum of our experiences. If you’re alive, conscious and have a brain you’ve got a bias.
And so it goes in trading. Some people are biased toward playing stocks from the long side. Others seem to be perennially short. Should I buy or sell Oracle (ORCL)? Or perhaps do nothing at all? Even nondecision is an active choice governed by your personal market biases.
What distinguishes the successful trader is that he understands his biases and knows how to overcome the ones that harm the bottom line. To help you do the same, here’s a look at the three biggest sources of trading bias.
The most common way biases are formed is through *previous experiences*. As a kid, it only took one serious burn for me to realize that touching fire wasn’t a very pleasant thing. More recently, we all learned that companies with a dot-com suffix have a strange tendency to deflate, decline or just disappear altogether. (more…)