Hindsight Bias: Don’t be Trapped By the Past
Market Meditations | May 14, 2021
Let’s look inside the mind of Geoff, a crypto trader who has been following markets casually over the last year. He has watched as the price of Ethereum has risen, becoming increasingly certain that he predicted the rise. At $2,000 he thinks, “I said this would happen”, at $3,000, “this was always going to happen” and at $4,000, “I knew this was going to happen”.
So what does Geoff do? He buys 5 ETH, convinced he can accurately predict the price. His problem? Geoff has fallen victim to hindsight bias. This is where an individual convinces themselves that they were able to accurately predict an event that has happened, when in reality this was not the case. Geoff, although a novice trader, has convinced himself he has an edge in the market and can accurately predict price movements.
Doing this in any area of life, especially cryptocurrency trading and investing can have devastating impacts. In reality, Geoff has no idea whether the price will continue to increase. He has made a trading decision based on overconfidence and frustration that he didn’t act, when in his mind, he had accurately predicted the move.
So what can we do to avoid falling into this trap? The most important step is to build a psychological framework ensuring your decisions are based on facts rather than emotion. This can act as a checklist you systematically complete before making any trade. For example:
- Have you double checked your analysis to ensure the trade fits into your system?
- Do you have clear stop loss and profit targets in place?
- What would happen if your trade had a negative outcome?
- Are you feeling any negative emotions such as anger, frustrating, FOMO or fear?
- Are you basing your decision on data or something that you are feeling?
Hindsight bias can have a highly destructive effect on our financial decisions. Build a psychological framework and avoid making the same mistakes as Geoff.