Recency bias occurs when a trader concentrates too much on their most recent trades, and so loses sight of the big picture. A winning run gives you a tendency to make poor decisions.
When a trader is on a winning streak or has had a large win in trading, they tend to believe that they can always replicate their wins using the same strategy. Therefore, winning streaks tend to trigger recency bias more frequently. Following a winning streak, it becomes more likely that the number of open positions and lots will rise to levels well above what a trader would typically be willing to take a risk on.
Because of a recent strong bull market, investors and traders may be susceptible to the effects of recency bias, making them adopt a bullish bias. Under such circumstances, traders can easily fail to recognize a change in the direction of the market for an extended period of time.
Similarly, traders who are still reeling from a decline in prices after a bear market ends may find themselves unwilling to invest in a new bull market. Recency bias can also present itself in the form of investors’ unwillingness to rebalance their portfolios to take advantage of the newest market leaders and instead stick with stocks that performed well during the previous upswing.
In the financial markets, investors may be caught off guard by every market move because their point of view becomes fixated on the most recent price direction, momentum, or volatility. They, therefore, become blind to even the most obvious market changes. Therefore, investing in the financial markets can be extremely challenging due to investors’ tendency to act too late depending on the most recent price movement.
The best way to stay focused on the larger picture
The insights and strategies below will help you avoid being affected by recency bias.
- Keep in mind that no matter what trading advantage or strategy you use, there will be winners and losers. To put it another way, even if you’re winning 70% of the time, you have no idea if a particular transaction will be a winner or a loser because winning trades are randomly distributed.
- Stay focused on your trading strategy. Having a detailed checklist of criteria, you must meet before engaging in any trade will help reduce emotional bias and recent history. Complacency is a trap you want to avoid, and if you’ve been losing, you’ll need to overcome uncertainty to avoid falling back into it.
- Treat each trade as if it were completely unconnected to the trade that came before it because it is. A big win in your last trade does not guarantee a repeat performance. For this reason, you must always be mindful of your thoughts and actions in the market in order to avoid being fooled by recency bias.
- When you’ve finished a trade, whether you won or lost, it’s okay to take a break. Allow yourself a few days away from the market to gather your thoughts and feelings. When you return, go over your trading strategy one last time before returning to the charts to get a good look at the bigger picture.
Keeping a record or a trading journal of your long-term performance is a great way to keep the bigger picture in mind. Logging the long-term/overall performance of your trading will help you gain the proper trading perspective that you need in order to make your decisions based on facts rather than being overly influenced by recent trades or returns.
- Keep a record of your trading strategies for each trade. Keeping track of your trading history is essential to helping you focus on the bigger picture. This gives you the opportunity to take a step back from your recent trading outcomes and look objectively at what is working and what isn’t working. This is the surest way to objectively assess your trading performance and identify areas where you can do better, as well as things you should attempt again if they’ve been successful in the past.
- Another technique to combat recency bias is to stick to your trading criteria and objectives. This will help you develop a disciplined approach to trading rather than one driven by emotion.
- To make it easier to find a good price action trade signal, create a brief checklist of all the things you’re looking for in a signal. By following this routine, you will reduce the likelihood of basing your next trade on your recent successful trade or hesitating from making an entry based on a recent loss.
Any effort to trade objectively will fail if your emotional state gets in the way. This is especially true when dealing with recency bias. Consider making a serious effort to review your trading history in order to acquire a more objective perspective of your trading performance.
To avoid recency bias, you’ll have to put in some work and trade with a high level of discipline. In other words, you have to be proactive in your efforts to overcome the overconfidence that comes with winning and the discouragement and fear that comes with losing.