Today’s lesson is going to help you eliminate one of the biggest psychological handicaps that is standing in the way of your trading success. First, we will identify the issue and then help you cure it and prevent it from returning. Essentially, we are going to ‘vaccinate’ you against one of the worst trading ‘diseases’ that ‘kills’ many traders each year…
This trading ‘disease’ is something that often develops following your last trade. As that last trade’s results permeate your brain, depending on whether you are trading properly and (or) are mentally prepared to deal with your last trade’s results, you may be at serious risk to getting stricken with this trading ‘disease’. Read on to learn what it is and how to vaccinate yourself from it…
Why your last trade matters so much, or does it?
Your last trade will tell me a lot about you as a trader and as a person. For example, does your last trade look consistent with your other recent trades? If it was a loser and I see it was 5 times as big as your previous loss, you’re doing something seriously wrong; all your losers should be very close to the same amount and some maybe at breakeven. Winning trades will naturally vary a little more (some 1r, 2r, 3r or more), but if I see many tiny winners less than 1R (1 times risk) and some super big ones, you are likely not on the right track either.
Your last trade can negatively influence your mindset and thus your next trade. Ideally, your last trade will have no effect on your next trade, but far too often for most traders it has a huge effect.
Your last trade only matters if you are trading wrong and thus allowing that last trade to take on too much importance. The fact is, your last trade should be totally irrelevant in the grand scheme of things, and so it should have ZERO impact on your mindset and your decision to take your next trade or not.
- If you just lost, it has no bearing on the fact that your next trade might be a winner.
- If you just won, it has no bearing on the fact that your next trade might be a loser.
If you stuck to your plan, whether it was a win or loss, you are on the right track. Re-read that last sentence again.
Recency bias explained in the context of trading
As I discuss in my article on the topic of recency bias in trading, a trader has recency bias when they focus too heavily on their most recent trading decisions / trades and lose perspective on the bigger picture. In other words, when a trader has recency bias, they can’t see the forest for the trees, so to speak.
“It is human tendency to estimate probabilities not on the basis of long-term experience but rather on a handful of the latest outcomes.” – Your Money and Your Brian, Jason Zweig
A trader can have both winning streak recency bias and losing streak recency bias.
- Winning-streak recency bias:
Winning streak recency bias says that traders who are on a winning streak (or who just hit a huge winning trade) are too heavily influenced by that winning streak. The implications of this are, traders may increase risk size on their next trade above what they are comfortable with losing and (or) they may enter increasing number of trades that violate their trading plan / trading edge. The primary psychological error at play here is over-confidence. As a trader wins, it’s human nature to perceive less risk in the market and start inflating their sense of trading ability and how much they were responsible for that last winner, to the point where it becomes detrimental. This usually ends in a massive loss or series of losses that quickly voids all the gains made during the winning streak.
- Losing-streak recency bias:
Losing-streak recency bias says that traders who are on a losing streak (or who just incurred a large loss) are also too heavily influenced by that losing streak. The implications of this are, traders may decrease risk size below their normal 1R risk amount and (or) they may enter decreasing number of trades due to fear of losing more. The primary psychological error at play here is fear. As a trader loses, it’s human nature to start perceiving more risk in the market than is really there and to start over-worrying about losses and this works to deflate one’s sense of trading ability and confidence. This usually ends up in missed opportunities and can result in a perpetual cycle of fear and losing until the trader ultimately gives up trading altogether, feeling jaded and even ‘scammed’ by the market.
- How to cure recency bias in trading:
I wish there was a magic pill that I could send you in the mail that would cure your susceptibility to recency bias in trading, but sadly, there isn’t. So, you’re going to have to listen closely and do what I say if you want to avoid this mental trading plague.
Avoiding recency bias in trading begins with knowledge, with education. You must first understand that it’s simply human nature to become overly-affected by your last trade’s results. Once you understand this, you will start to become more self-aware and hopefully you’ll catch yourself in the middle of becoming too influenced by your last trade. This is your cue to take a break, step away from the market for a day, go read a book, play golf, do whatever, and come back tomorrow or the next week, after all, the market will be there tomorrow. Maybe not what you want to do or hear, but it works, trust me.
