Trading Psychology Series: How Confirmation Distortion Distorts Your Trading Decisions
Why This Bias Matters More Than You Think
In today’s world of fast research and easy information, it is easy to fall in the trap of searching the right keywords to find the answer you want to read. Believe it or not, it’s especially relevant when applied to trading because it distorts your perception of reality. It can trick your view technical analysis and believe it says what you want it to say rather then what it really says.
It does affect all kinds of traders and leads to stubborn losses and hasty exits. It can make you break your own trading rules and make you believe you are above the markets. This bias will slowly reduce your edge and make your profitable strategy lose money, bit by bit.
understanding it is the first step in avoiding that death trap and replace it with more data driven information that allows you to trade probabilities rather than narratives.
Core Psychological Concept: What Is Confirmation Bias?
The confirmation bias is very common nowadays. It’s simply the tendency of people to search information to support something they believe to be true. It is often doubled with the dismissal of contradictory evidence, even when it’s overwhelming. Meaning the person searching it will most likely interpret all ambiguous data as supporting your own belief.
The perfect example of this is the person searching on google for “do vaccines cause autism in children?” instead of “have studies found any connection between vaccines and autism?” It will give you two completely different arrays of results.
Let’s get back to the trading business now. The problem with the confirmation bias in trading is simple: Markets are not driven by conviction or beliefs, they react to supply and demand, buyers and sellers.
Why Is The Brain Doing This?
You might ask, well if it’s bad, then why is my brain doing it to me? Simply because humans like comfort better then accuracy. Being uncertain of something brings some stress, it’s out of control. I will not linger too long about the 4 causes of stress but basically it’s one or a combination of 4 elements which are: not in my control, uncertain, new or it affects my ego. These 4 factors are the only ones that causes a stress reaction for humans.
How Confirmation Bias Hurts Trading Performance
Cherry Picking Evidence:
A trader who has a guy feeling of a bullish sentiment might only highlight a single candle, define the support and resistance to be too permissive or puts too much weight on an indicator’s signal.
He could also ignore the lack of volume, the lack of momentum ot even ignore a complete indicator.
Timeframe Shopping
As obvious as it sound, a trader wanting a pair to be bearish could go across all time frames to find a setup that would possibly agree with his bias. Even if his system calls for a specific timeframe. It’s confirmation bias disguised as analysis.
System Rule Override
This is for everyone following a structured way of trading. If the trader neglects a rule or even take a trade when an indicator tells otherwise, it’s confirmation bias. It will go around the statistical edge and change the whole picture.
While you will rarely find a confirmation bias wipe your account overnight, it will cause small changes to your trading ways and over time, will erode your system’s results.
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Practical Methods To Neutralize Confirmation Bias
The Opposing Point Of View
Before entering a trade, ask yourself the opposite narrative. It can look a little like “what would someone who thinks the opposite way would say to argue with my decision?”
Write down both points and ask yourself if both narratives are valid. If not, you might be falling in the bias. While this is not a 100% truth, it will help you point out when you do have a bias.
The Balance Rule
Before taking a trading decision, instead of asking yourself “do I have enough confirmation?”, ask yourself “is it a one sided evidence of my confirmation?”.
If all your arguments point in one direction without acknowledging on the risk factors, you are at risk of a confirmation bias.
Balancing your analysis does not mean not taking decisions, it means honestly looking at facts before taking one.
The Review Post-Trade
Assess your trade decisions every week to find confirmation biases. Then, in your trading journal, add a small tag CB-Yes or CB-No. If you see the CB-Yes appear more and more often, over time, you might want to address the situation.
Confirmation Bias In Algorithmic System Trading
Confirmation bias will not completely disappear when you automate our trade, it will simple applies on a more macro way.
System Design Confirmation Bias
Indeed, it can show up while choosing indicators that feel right or interpret some results a certain way. The simplest way to avoid it is to define what metrics you are looking to improve, enter the data in a table and come up with a scoring process that will allow you to compare your indicators with no emotions. Hard truth is that the indicator that works the best might not look good, but will work well!
Optimization Bias
You might have seen this one coming but yes, it is possible to over optimize your system. You might want to optimize your results until the results match some specific expectations. You might ignore poor sample performance.
There is a reason why I always recommend making your algorithm work with at least 15 pairs before even trying to run a demo account. The system must have some adaptability embedded to it. Having a system work only with 1 specific instrument is likely overfitted and will lead you to losses, sooner or later.
The Override Bias Pattern
You might have an EA running that you like. However, traders will look at the live results on a regular base and it gets very tempting to perform some actions such as moving a stop loss or closing a trade. This applies to winners ad well as losers and will result in your system not performing as expected.
The system was working in the backtests, it will perform the same way when on the market.
Objectivity Is A Skill You Can Train
Confirmation bias is something normal that can happen to anyone. It’s a normal trait that feels comforting and it’s something normal. However, trading depends on a certain level of discipline that can be trained over time.
You must always remember to challenge your assumptions, seek contrary evidence and compare the outcome to what you are doing and develop your skills to trade in a structured way.
The market does not reward confidence.
It will reward accuracy, discipline and adaptability.
