All Trade Ideas and trading scenarios found on FX360.com are hypothetical. FX360.com has not placed these Ideas in a live trading environment. Forex Trading involves high risks, with the potential for substantial losses that exceed your initial deposit and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

Trading Psychology- Recency Bias

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

Last updated 2/25/2010 7:32 PM EST (GMT -5) 6 Comments

• Share this:

Bradley W. Gareiss

Technical Analyst, GFT

Recency bias may not be a household phrase, but I guarantee that anyone who has ever traded has experienced it.  Recency bias is the tendency for traders to place more importance on more recent trades and to place less importance on less recent trades.  This phenomenon is not limited to trading of course.  Another example would the history of the all star game in Major League Baseball.  If you asked the casual baseball fan who has won more all star games, most people would say the American League because they have not lost since 1996.  However, the National League has actually won 40 games to the American League's 38.

Let's get back to trading.  Recency bias can have a very negative effect on a trader's results.  Let's say that two traders have the exact same profitability over the course of 2009.  However, Trader A has won his last 3 trades, and Trader B has lost his last 3 trades.  Even though they have made the same amount of money over the year, who do you think feels more positive?  Trader A, of course.  In fact, Trader A probably feels like he can run through a wall and will never lose again after winning 3 consecutive trades.  Of course Trader A has lost plenty of trades, but chances are the past 3 trades will make him euphoric.

Euphoria will likely lead to bad decisions by Trader A.  Trader A will ignore possible warning signs and enter a trade that typically does not fit his criteria.  This increases the odds of a loss.  Shaking his head, Trader A cannot believe he ignored those signs and gave back some of the profits from his recent win streak.  Even if he is able to right the ship and go back to a neutral mindset, he still lost a trade due to a mental error.  Of course, every trader will lose plenty of trades, but emotional errors (such as this one caused by euphoria) are the reason most traders that would otherwise be successful don't live up to their potential.  If Trader A does not become emotionally neutral after his euphoria driven loss, the damage to his account can be even greater.

Back to our example, Trader B probably feels as if he will never win a trade again after losing 3 straight trades.  Sure, he has won plenty of trades and is very profitable on the year.  However, those 3 trades have him thinking very negatively.  Trader B will likely make one of two mistakes at this point. First, he could abandon his rules and jump into a trade that does not fill their trade criteria because their criteria hasn't worked for the past 3 trades.  This sounds irrational because that same criteria has led to long term profitability, but I would wager most experienced traders have done exactly what I just described at some point.  Second, Trader B could pass up on a perfect trade set up that fits his criteria because he is scared of losing again.  Both scenarios can be disastrous to a trader's mindset.

Clearly, it is important to avoid these mental mistakes and minimize the effects of recency bias.  So how do we avoid succumbing to the negative mental influences that can be caused by recency bias?  The first step is to keep a track record that includes every trade, how much was won or lost, and total equity.  That way you can accurately track progress over a long period of time.  This makes it much easier to think about results on a long term basis.  If trades are not tracked, the past few trades will have a far greater impact on your mindset.

The second step is to write out a trade checklist with your trading criteria.  That way, you are more likely to not enter a trade unless it fulfills all of the criteria.  You also will be more likely to enter every trade that does fulfill your criteria.  This may seem meaningless, but it is much more difficult to ignore your trading rules if you have to physically put a check mark next you each of your criteria before taking a trade or passing on a trade.

The third step to minimizing recency bias is to know yourself.  Some people are more emotional than others.  If you are prone to making emotional decisions, take a day off from trading if you have lost or won 3 trades in a row.  Trading under emotional distress is not profitable.  If you handle your emotions well, perhaps waiting that day is not necessary.  Usually a full night's sleep will help negate recency bias, especially if you have a detailed track record to go over the next morning that reminds you long term results are more important than the past couple of trades.

Remember, it is very challenging for the human brain to completely overcome recency bias.  However, its effects can be devastating to a trader's mindset as well as their equity.  Therefore, it is important to take the above steps to minimize the negative effects created by recency bias.

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

The views of the authors and analysts are not necessarily those of Global Forex Trading, its owners, officers, agents or other employees. FX360.com and the currency research team will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on FX360.com. Global Forex Trading and the currency research team do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

• Share this:

Comments (6)

Silenus

February 25, 2010 at 08:32 PM ET

Winning or losing streaks shouldn't really affect the trader or his clients... but they do.
Things I think about when they happen:
If your methodology has a positive expectation, you're more likely to have winners in the future.
If you are a 'discretionary' trader, the market is trying to tell you something, listen.
Track records don't lie - well at least they lie less than your emotions. Remember it all just one big trade.
The big question is : Increase or decrease position size? I say no; others a lot smarter than me say yes.
Guess it depends on the trader.
(By the way was that Long Term Capital stat true or were you just trying to scare me?)

bgareiss

February 25, 2010 at 09:01 PM ET

Check out "When Genius Failed: The Rise and Fall of Long-Term Capital Management". Brad

Silenus

February 26, 2010 at 04:42 AM ET

Discussed your article with a friend.
He mentioned another factor : time taken to reach a new equity high (in other words the duration of the drawdown/losing streak)
Obviously the time taken to recuperate losses is important for the trader and money manager.
Should this influence your methodology? Again I say no; he says 'sometimes yes'

Whit

February 26, 2010 at 09:53 AM ET

Excellent article and first I've heard anyone mention using a check list. Being fairly new to this and having endured some heavy losses, I finally did just what you suggest. Put my "trading rules" into a check list format, made a stack of copies and use one for each trade. It has made a big difference in my success/fail AND pointed out some glaring deficoencies in my "rules" and overall trading plan.

MoneyManager

February 25, 2010 at 08:35 PM ET

Nice write up. There is another mental trap that readers might want to be alert for, called psychological set. In pilot training, this was explained as the tendency to miss an aberration in any set of tasks in which, usually, there is no aberration. For example, pilots have a sequence of many steps in preparing for a landing. Some of them are physical operations that need to be performed, and some are simply checks, where no performance is required if the data is as expected. A pilot will go through these routines so many times, with no red lights, that it becomes amazingly easy to miss a red light even when it's right there. Even using checklists, which have been proven to reduce mistakes, pilots can still fail to catch a dangerous outlier in a sequence that they have repeated so many times without a single dangerous outlier.

I think that trading is considerably less routine than piloting an aircraft (pilots will mostly agree with me, non-pilots are usually shocked to hear this), but some clear dangers overlap. Did you remember to verify that order ticket? *Every* time? You expect it to have been marked as a Sell, but did your mind fail to catch the fact that the Buy side was ticked? Extra zero in there by accident that you missed?

Thanks again for the write up.

alexjbrandt

February 26, 2010 at 03:23 AM ET

I've accidentally placed a long position when I meant to place a short position. Only have to do that once to learn to review the order lol.

Add Your Comment

Please login to post a comment or sign up for an FX360® account.

Loading...