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Trading is as much about psychology as it is about market analysis. Two common cognitive biases that can affect decision-making are the availability heuristic and recency bias. Both can lead traders to make choices based on flawed reasoning, which can result in poor outcomes. Understanding these biases can help you make more informed, rational decisions.
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Everybody knows this feeling and also knows it is a false feeling. You're in a casino, and the roulette hits red. Then again and again. After three, four maybe five times red in a row, you start to think it's time for the roulette to hit black. Now, in this simple case, you know that's not true.
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The hot hand fallacy in trading is a cognitive bias that occurs when traders believe that a winning streak will continue, even though the probability of success remains unchanged. In other words, traders may think that because they have experienced a series of successful trades, they are more likely to continue to make successful trades in the future.
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Now and then when I'm reading an article from the world of behavioral economics discussing a particular phenomenon, it makes you realize once again how much trading and investing is about human behavior.
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We have discussed this issue multiple times before. When you are trading, you have to let go of your ego. This also applies to the kind of news a trader reads or the kind of chat rooms and forums the trader is taking part in. Some websites always bring bullish news and opinions. Others are always bearish. Most often this is not high-quality journalism, but more like someone with a loud voice claiming all sorts of things.
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It's been over a year now since we've witnessed the so-called flash crash. On May 6th, 2010, within minutes the markets dropped several percent, then bounced and recovered a large part of the losses. To relive those exciting moments, here are some video clips. If you know of any other clip that should be here, please send me an email. This post with video clips is mostly fun, but it's also showing us panic, anxiety, greed, and fear. Besides crash flash videos, there are some other clips that show the emotions that sometimes come with trading.
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Frustration among traders is very common when they go short on anticipation of bad economic data (or long on good economic data). This is due to the fact that in many cases the market does not always come down on bad economic data, or vice versa does not always rise on good economic data. Bad is good sometimes, and good is bad. Traders are frustrated because the market is not doing what they think it is 'supposed to do'.
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Interactive Brokers (IB) is a popular broker, operating in several counties around the world, usually under local national names. Their trading platform is the same everywhere, it's the Trader Workstation or TWS. For novice users, it may be somewhat intimidating at first glance, but once you get a good understanding, you'll see it has a lot of powerful features to offer.
We have learned that disciplined trading is the only way to survive in this business. The best way to adhere to your own strict trading rules is to automate things. Let your orders take care of your trading, not your brain because the human brain usually fails in (short-term) trading. In order to achieve this, we need an extensive set of order types. TWS has just that, so let's get into it.
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Sometimes, the most simple and basic ideas can lead to better performance in trading. As we know, trading is a lot about having rules and obeying them. Maybe, when those rules are complex or can be bent, it's more likely that they will be broken. A simple rule has, therefore a good chance of being applied in a very rigid and disciplined way. In this article, I will share a very basic and easy rule that I use and have used for quite some time now. I call it the One-Trade-Per-Day rule. As you can guess from the name, that doesn't sound like a very ingenious idea. And it isn't, but it works.
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Oftentimes, traders feel that the market is full of opponents called 'they'. Traders have the feeling that 'they' (these opponents) are out there to get them. 'They' are pushing the market higher after which 'they' will let it drop. 'They' will hit your stop loss and then 'they' will steal your money. Usually 'they' are the banks, the big funds that can really move the markets. In other words: The Evil. And what 'they' are trying to do is always so obvious, it's almost a crime.
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If you use any search engine and type in the phrase "How to become a successful short-term trader" or anything similar, you will find roughly 70 million(!) websites that will help you in achieving that goal, or so it seems. In reality, there's only one right and honest answer which is more like this: "There is an extremely low probability you will ever be successful in short-term trading, and you will most likely lose all funds in your account".
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We have all heard of the famous experiment by the Russian physiologist Ivan Pavlov where dogs have been conditioned to expect food following a particular event. The Pavlov dogs have experienced the same sequence of events so often, at some point they know what's coming next without really thinking about it. They start to show emotions 'in advance', and salivate even before their food is served. This is one form of conditioning.
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If you have a losing trade that was stopped out, and maybe a string of losing trades, this might upset and frustrate you as a trader. You start to wonder how you ended up on the wrong side of the market each and every time.
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The trading world is known for its beautiful one-liners that are all so true, but at the same time so extremely difficult to practice. Some of the most well known around are: "Cut your losses and let your profits run." or "The trend is your friend." (until it isn't), just to mention a few. Collecting more of those one-liners would be a great subject for another article. This post deals with getting with the trend.