Crypto investing holds greater volatility than traditional markets, but it comes with very similar behavioural biases. While the potential rewards are enticing, it’s crucial to understand the potential pitfalls associated with all trading. As we are all human, behavioural biases are a part of our nature, and they impact our decision-making process, which holds true for investing and trading as well. In this blog post, we’ll explore how behavioural biases influence our crypto trading and how we can mitigate their effects.
In the world of investing, overconfidence bias frequently causes individuals to overvalue their knowledge of financial markets or particular investments while ignoring crucial data and expert opinions. This mindset typically leads to misguided efforts to predict market movements or focus heavily on high-risk investments perceived as guaranteed winners.
Overconfidence bias tricks the brain into believing it's possible to consistently beat the market by making risky bets
It shouldn’t come as a surprise that overconfidence may pave the way for subpar portfolio performance for many investors. It might cause clients to misjudge their risk tolerance, leading them to allocate funds to risky investments that do not align with their needs. If the investments don’t work out, the bias can easily hurt the investor’s funds as well as their psyche
Regret avoidance (also known as regret aversion) is a theory used to explain the tendency of investors to refuse to admit that a poor investment decision was made. Risk avoidance can lead investors to hang on to poor investments too long or to continue adding money in hopes that the situation will turn around and losses can be recovered, thus avoiding feelings of regret. The resulting behaviour is sometimes called escalation of commitment.
Regret avoidance is when a person wastes time, energy, or money in order to avoid feeling regret over an initial decision. The resources spent to ensure that the initial investment was not wasted can exceed the value of that investment. One example is buying a bad car, then spending more money on repairs than the original cost of the car rather than admitting that a mistake was made and that you should have just bought a different car.
Fear of missing out (FOMO) in the crypto world happens when someone makes a hasty decision to trade or invest in a digital asset without carefully checking the accuracy or source of the information they received.
FOMO in cryptocurrency can cause people to buy assets when prices are at their peak or sell when prices are at their lowest instead of doing the opposite, which would be a wiser approach. Sometimes, the effects of crypto FOMO can be more severe and far-reaching than just losing invested money—it can lead to negative outcomes like losing touch with family, experiencing anxiety, and even suffering from depression.
To overcome these behavioural biases and make better-informed trading decisions, consider the following strategies:
The first step to combating biases is acknowledging their existence. By becoming aware of them and how they affect us, we can better identify when they are influencing our decision-making and work to mitigate their effects.
Creating a well-thought-out trading plan can help minimise the impact of behavioural biases. A comprehensive plan should include your trading goals, risk tolerance, and exit strategies for both winning and losing positions. By having a plan in place, you can avoid making impulsive decisions driven by emotions.
Diversifying your crypto portfolio can help reduce the risks associated with behavioural biases. By spreading your investments across various digital assets, you reduce the likelihood of being overly confident in a single asset or succumbing to the herd mentality.
Set trading rules that never change. For example, if an asset loses 7% of its value, sell it. If the asset rises above a certain level, set a trailing stop loss rule that will lock in gains if the trade loses a certain amount of gains. Make these levels unbreakable rules, and don't trade on emotion.
To counteract the impact of biases, consider seeking expert advice and continuously educating yourself about market trends and new investment opportunities. Learning from experienced traders and staying up-to-date with the latest developments can help you make better-informed decisions.
Lastly, taking breaks and practising mindfulness can help you maintain a balanced perspective and reduce the influence of behavioural biases. By taking the time to reflect on your trading decisions, you can gain clarity and better understand the factors that may be driving your choices.
Behavioural biases can significantly impact our decision-making process when trading cryptocurrencies. By becoming aware of these biases – including overconfidence, confirmation bias, loss aversion, and herd mentality – we can take steps to mitigate their effects and make better-informed decisions in the fast-paced world of digital assets.
To overcome these biases, consider developing a comprehensive trading plan, diversifying your crypto portfolio, seeking expert advice, and continuously educating yourself about market trends and investment opportunities. Additionally, practising mindfulness and taking breaks can help you maintain a balanced perspective and reduce the influence of biases on your trading decisions.
By understanding the impact of behavioural biases on our crypto trading and implementing strategies to minimise their effects, we can better navigate the volatile world of digital assets and increase our chances of success in this exciting and rapidly evolving market.