Becoming A Better Trader by Overcoming Cognitive Biases in Crypto
Over the years, the Crypto space has evolved with more people showing interest. People venture into the market with the hope of being a badass trader, however, their cognitive biases work against them.
So what exactly is this cognitive bias that prevents you from being a better Crypto investor? It basically affects the decisions and judgments you make when processing or interpreting information in the world around you.
Imagine you hear news of a coin at an all-time high and you Fomo’ed into the coins or you ditch your blue-chips for shitcoins guess what? That is your cognitive bias messing with you.
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So let’s take a look at fourteen (14) major cognitive biases in crypto:
Unit bias:
Why do you think meme coins explode? People actually choose to purchase a token based on a “whole unit” instead of a fraction of it. Just like you are advised not to judge a book by its cover, don’t judge the value of a token-based on its “cheapness”.
Rather, put in the effort to understand how market caps work.
Anchoring bias:
Yes, we all know information is key but over-reliance on the 1st piece of information you have can be misleading. You heard about Bitcoin at $1,000, you missed out. Then it goes up to $5,000, boom, to you that goes your opportunity to purchase it as you deem it as “overpriced”
In this case, instead of evaluating it based on its POTENTIAL, you focused on its PAST.
Confirmation bias:
“I heard XYZ talk about B coin, which means it is worth investing in. Whatever anyone else says is false”. This is your confirmation bias at work. You only seek out information that tells you what you want to hear and only follow people that say good things about X coin. You quickly cancel out anyone else spreading “FUD” (Fear, Uncertainty, and Doubt ).
Learn to invest your time in seeking and researching the FUD to see if it’s valid before you put your money. Do not dismiss it at a glance.
Sunk cost bias:
You know how they say “you lose some and you win some”, this applies in the crypto space. There are costs that occur that can’t be recovered. Losses are bound to be made, but chasing those losses is a sure way to doom.
We have a tendency to keep investing more money or over-committing because we’re scared of losing our original investment. Assuming you’ve invested $10k into a coin but you are -80% on a coin, which means you are left with $2k. Then you think, let me invest more to get back my initial investment of $10k.
This is you throwing good money after the bad. Even though you are -80% down, you still have 20% of your investment left and you are better off investing this somewhere else than chasing after your losses.
Loss aversion:
Losing $100 when your entire portfolio is just $150 is painful. The pain of losing money is way worse than the feeling you have when you win money. A study shows that the brain typically assigns 2.5x to a loss. Imagine you are down horrendously on your portfolio and the worse news is still brewing. You can decide to cut the trade & count your losses.
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But in a different scenario, some people will prefer to wait it out. This is Loss aversion. One who is afraid of losing money will definitely avoid taking risks. There have been several rugs in Defi, some people who were a victim of these rugs have vowed never to invest in Defi again!
But yet again, how do you make life-changing money if you don’t risk it? Rather than avoid risk, it is best to weigh the risks vs rewards properly.
Recency Bias:
This occurs when you overweight recent information and events. You tell yourself “BNB’s price is boring. Let me chase low cap coins” Then the bear market comes and you get burnt.
You can beat recency bias by zooming out on the charts.
Overconfidence Bias:
One of the cognitive biases in crypto is Overconfidence bias. Here is how it works. You started with a portfolio of $500 and in 3 months it has grown to over $5,000. Then you tell yourself, I am the best trader thereby overestimating your own abilities. We get lucky a few times and think we’re smarter than we really are.
Overconfidence kills & it is best to rely on solid risk management strategies. You don’t want to lose what you gained to the market.
Endowment Effect:
In a volatile market, emotions are nothing but baggage. You bag a coin and make great gains on it over time and become emotionally attached to your bags. I see this a lot with ETH maxis, they become emotionally attached & choose to ignore all other L1’s.
You need to have zero-based decision-making to get over this. Ask yourself: “If I didn’t own this investment, would I invest in it today?”
This keeps your decision more neutral.
Survivorship Bias:
So it happens that Brad Pitt was a waiter who moved to LA, but guess what? He is now a movie star. Does that mean if you do the same thing, you will become a movie star? Many people have followed his path hoping to do the same but we don’t hear of the thousands of other people who tried the same and failed.
Someone turned $8,000 of Shiba Inu into $5.7B, you don’t hear about the thousands of others who turned $8k into $500. Only the winner has the spotlight when it comes to the media & such stories affect your perception of the odds.
Don’t let such stories cloud your judgment. What works for others might not work for you.
Narrative Bias:
Stories can be fascinating and humans sure do love to hear stories. It gives us the opportunity to make sense of what’s happening around us or the world generally. The narrative comes up and people buy into these narratives. Some coins explode because of the story.
Don’t just buy the story or narrative.
Herd Mentality Bias:
Humans can be easily influenced by what they see or hear. Instead of doing their own independent analysis, they choose to just go with the crowd.
That is the spirit of FOMO (Fear Of Missing Out), you are copying what other investors are doing. Learn to do your own analysis before investing in a token rather than focusing on herd mentality.
Availability Heuristic:
After a major airplane crash, there’s usually that fear of flying that accompanies it & you decide on road trips henceforth. In these scenarios, you choose to make judgments based on how easy it is to remember information. You didn’t notice that 1 in 9,821 dies in a plane crash and 1 out of 114 die in a car accident. Planes are actually much safer.
This availability bias applies in Crypto also as it shows in marketing. A good marketing strategy can lead to a coin pumping but behind the great marketing, be sure it isn’t a terrible project that lies beneath.
Outcome Bias:
Outcome bias is an error made in evaluating the quality of a decision when the outcome of that decision is already known. Imagine investing $10k into a shit coin and boom you are worth over $100k. Did you make the right decision?
No, but yes, you did have a great outcome. Now, imagine the scenario was replayed a thousand times. You have to account for variance. You can do everything right and yet the outcome still won’t be right. That’s life. You don’t always get what you want. But you should always make the decision with the best ODDS and PROBABILITY.
Authority Bias:
We have the natural tendency to follow those we call leaders without questions. Once we believe someone is an expert, they can’t possibly be wrong in any way. But we need to understand that: Leaders are humans and even if they are experts, they can be wrong and also have ulterior motives.
So don’t be deluded and deceived.
Steps On Stopping Cognitive Biases In Crypto
After making you aware of these cognitive biases in crypto that you have developed over time unknowingly, I am sure that you want to know how to stop them. Well for starters, being aware of them is the first step. Do you want to lower the damages it causes? Then you can:
- Call them out
- Develop a Cognitive Bias Checklist: this will keep you on your feet when making an investment decision by keeping you aware of your thinking bugs or errors.
- Consider creating your own systems for investing: this will help to keep your emotions in check. Like I earlier stated, emotions shouldn’t rule you.
- Keep a trading log: You can create a spreadsheet to monitor and keep records of all your trades. This can be used for analysis on your end.
So instead of letting Cognitive Biases in crypto ruin you, use them to your ADVANTAGE. Understanding it means you can profit from others. Imagine a coin that has a good narrative, a charismatic leader, great marketing & herd mentality. It becomes a case of the more cultish it is, the more profitable it can be. Never forget to take profits along the way.
