26 psychological biases lead to losses in crypto trading and investment — here's how to avoid them

26 psychological biases lead to losses in crypto trading and investment — here's how to avoid them

Nobody is 100% rational: all of our decisions are influenced by the way our minds have evolved over time. As a result, people often make wrong decisions in trading and investment that are based on emotion, leading to preventable losses.

Because the digital asset market doesn’t yet have the same kinds of robust valuation models that exist for stocks and bonds, participants are even more prone to making irrational decisions. In this post we will review the most common emotional and behavioural biases and suggest strategies for how to avoid them.

It’s a long post, so it’s best to bookmark it and use it for reference. Being aware of these biases will help you to trade with less emotion and more discipline, and to be more consistently profitable.

1. Loss aversion

People want to avoid losses more than they want to make profits.

Often traders (i.e. bagholders) are reluctant to sell assets that are deep in the red, because that would mean realising a loss. Instead, they hope that they’ll go up again at some point.

Similarly, greedy traders who are prone to this bias will sell winning positions to quickly avoid any potential losses that might happen if the market suddenly moves against them.  

“Now that I’m down 90% I might as well keep these bags or I’ll beat myself up when they pump.”
“Wow, BTC is up $500 since I bought it, I should sell it before it drops again.”

How to avoid: have a plan for when you are going to take profit or cut losses and set appropriate orders for short-term trades.

2. Endowment bias

Investors often irrationally value an asset more highly, simply because they already own it.

True ‘hodlers’ take pride in never selling, but this could lead to missed opportunities. Some might even say that they don’t care about the price at all.

How to avoid: try to think about the asset independently. Would you buy or sell at this price if you didn’t already have it? Act accordingly.

3. Affinity bias

People might make decisions based on how they believe the purchase of a given asset resonates with their values.

An example would be buying tokens that advance privacy, help the unbanked, or solve whatever issue is close to your heart. It’s great to support a project you want to succeed, but it has little to do with potential returns.

How to avoid: if your motivation is profit, try to think impartially and separate price from any implied values.

4. Anchoring and adjustment bias

Traders anchor at a certain price and don’t adjust even when there is information that could lead to further declines.

Someone who has bought a coin at a round number (BTC at $10k, ETH at $1,000) might want to wait until it returns to that price, even when there are other opportunities in the market. Then there is a lot of price action at those levels.

How to avoid: adjust your targets independently as if you had entered at today’s price.

5. Outcome bias

People (especially gamblers) often make decisions based on the outcome (winning at roulette) and not on the process (getting lucky with 37-to-1 odds) that led to that outcome.

“My friend got rich by buying this asset, so I better buy it fast.”
“I never sold BTC in 2013 and that worked well. I should just never sell BTC.”

How to avoid: remember that the outcome (e.g. making a profit from a specific asset) is the result of a process (buying and selling at the right time). Don’t blindly copy a strategy that worked for somebody in the past. Instead look for the factors that led to that outcome.

6. Mental accounting bias

People group money and assets into different mental accounts: “this is for long-term investments”, “this is spending money”, etc. Money is still money.

This could lead to excessive risk-taking, for example if you have some ‘play money’ gained from successful deals and then keep making high-risk trades with that money.

Or you might have a separate ‘hold’ fund that you never sell. You don’t then rebalance the whole portfolio and might once again take on extra risk by being overexposed to your favourite asset after it rapidly appreciates.

How to avoid: understand that money is money and evaluate your whole portfolio without dividing it into subaccounts.

7. Snake bite bias

Investors who suffer big losses tend to avoid all risk.

If you’re down 99% on most altcoins, it’s tempting to just stick to Bitcoin or even leave crypto altogether.

How to avoid: understand that drawdowns are inevitable and remind yourself of your long-term investment thesis and strategy.

8. Illusion of control

People think they can control outcomes even when they cannot.

When an exchange has a slick interface and it’s easy to use advanced order types, people tend to make too many trades just because they think they’re in control. That’s exactly what exchanges want – more commission fees!

How to avoid: remember that you can’t control the market or even your positions – there has to be someone on the other side for any order to be executed.

9. Availability bias

People make shortcuts and use whatever information is available.

Someone (not you, of course…) might buy a token simply because it’s everywhere and avoid tokens that they don’t know much about. Following the herd is never a great idea.

How to avoid: seek broader views, read other people’s opinions (understanding their reasoning, rather than simply their conclusions) and try to find the gaps in your information.

10. Self-attribution bias

People tend to credit their own skills when winning and blame their failures on something else (a bear market, whales, the government, etc.).

Everybody is a genius in the bull market. This illusion might cause traders to trade too much when profitable or otherwise fail to learn from past mistakes.

How to avoid: value failure and learn from every mistake. You’re the one who has made every decision, including the bad ones. The more mistakes you make, the better the trader and investor you will eventually become. Yet mistakes don’t have to be costly – you can practise market analysis with Cindicator and win crypto for correct forecasts without losing anything if you’re wrong.

11. Recency bias

This is about overemphasising more recent events compared to those that are further in the past.

You might focus on yesterday’s big 35% pump and ignore the fact that the asset is down 95% from its all-time high and has been sliding for months.

How to avoid: zoom out on the chart and read older posts and stories.

12. Cognitive dissonance

We all strive for consistency in how we view the world. When there is a conflict between our beliefs and new information, we feel psychological discomfort. These unpleasant feelings are known as cognitive dissonance and could lead to irrational actions when we try to resolve the conflict between different beliefs.

In trading and investment, people might ignore or avoid new information that could lead to a better decision if it also suggests that their earlier actions were wrong.

For example, you might sell an asset because you think it is going to zero based on a lack of progress on the roadmap. If it goes down, you feel good. You might later ignore new, positive information, however, as it conflicts with your earlier views (“it’s going to zero”), meaning you could miss out on a rally.

How to avoid: first, recognise the unpleasant feeling that comes from having an internal conflict. Then carefully examine your beliefs and decide which one is closer to the reality. Easy to say, but hard to do!

13. Self-control bias

People often act against their long-term interest because they simply can’t control their emotions.

Everybody knows that to lose weight they should eat less and exercise more, but emotions get a hold on us and we eat that piece of cake…

Similarly, most investors know that dollar cost averaging usually works better than trying to time the market to enter in a single large trade. Yet it’s easy to simply delay investing because “the crash is coming soon” and you need to buy a new pair of sneakers today.  

How to avoid: realise that you’re probably overestimating your ability to control your emotions and instead create a coherent strategy to determine your actions.

14. Confirmation bias

We tend to subconsciously support ideas that confirm our existing beliefs and belittle ideas that contradict these beliefs.

Crypto tribalism is a great example of this: maximalists from one camp simply ignore ideas from maximalists from other camps. They unfollow and mute their opponents, ending up in an echo chamber that only strengthens their maximalist beliefs. This is a great recipe for missing opportunities.

How to avoid: actively seek opinions that challenge your beliefs, talk to others and engage in discussions (this is where Twitter, TradingView and Cindicator’s chat come in handy), or try to think about situations from different perspectives.

15. Hindsight bias

We tend to remember our predictions as more accurate than they really were.

Of course, you also predicted that BTC would bounce back after hitting $3,500… that was obvious (in hindsight).

This bias can cause us to overestimate our forecasting ability, leading to excessive risk-taking.

How to avoid: make forecasts with the Cindicator app and keep a full track record of daily and weekly predictions. Even if they turn out to be wrong, you’ll have data on your own views. Seeing your true forecasting accuracy is a sobering thing and can cure compulsive trading.

16. Representativeness heuristic

People often estimate probabilities based on events that do not accurately show the full picture.

Representativeness is a shortcut in thinking where we try to estimate the probability of A belonging to B based on how similar A appears to B.

In the stock market, retail investors often mistakenly think that if a company makes high-quality goods, it’s a good investment. It’s true that companies that have made a lot of money for investors usually have good products, but having a top-notch product doesn’t mean that the company is a good investment right now – it might be overvalued or have problems with profitability, slower growth, and so on.

With digital assets, there are often no products, so it’s even easier to pay attention to superficial attributes that are associated with successful projects: sleek websites, big brand partnerships, national media coverage, etc. Of course, none of these indicate that a token is a good investment.

How to avoid: remain open to the possibility that the situation in front of you might not fit the stereotype and be cautious of the common attributes of success when evaluating investments.

17. Overconfidence

This is an emotional bias, where traders have unreasonable belief in their skills and abilities.

When you have several winning trades in a row it’s easy to suddenly believe that you’re a genius trader. This is dangerous, especially if you’re loosening your strategy and making more trades. Things can go against you at any moment!

How to avoid: remember to take your time and ask yourself what the risks are, especially when things are going really well for you.

18. Paradox of choice

More choice is supposed to be good, but too many options might lead to analysis paralysis.

When you have the opportunity to trade hundreds of tokens, it’s easy to get stuck in the research phase and never actually invest. Making any decision therefore takes more time and increases the risk of mistakes and regrets.

How to avoid: you can narrow down your list of potential assets by starting with a top-down analysis and selecting a specific niche/sector, or simply focusing on large caps if you want greater liquidity and small caps if you are seeking higher risk.

19. Regret aversion bias

To avoid having any regrets, investors might not take any action at all.

This is where you don’t sell your bag to avoid beating yourself up if in case it bounces.

Also, to avoid the regret of missing out on a bull run, people can end up buying mooning assets without doing the proper research.  

How to avoid it: understand how regrets have affected you and your past investment decisions (e.g. did you FOMO buy or hold on to bags?) and take this into account when evaluating your next investment.

20. Unit bias

People might buy more of a whole than if they were buying a fraction.

“I can only buy 0.01 BTC… but I can buy a whole Litecoin or thousands of XRP!”

For some reason it just feels better to buy a whole unit than a fraction. As a result, ‘cheap’ tokens that costs pennies catch the eyes of new investors exploring the crypto space, while Bitcoin and Ether might look “expensive”.

How to avoid: recognise that you might have a desire to ‘round up’ by buying more, and look at altcoins in satoshis rather than USD to make it harder for your brain to categorise tokens into ‘cheap’ and ‘expensive’.

21. Information bias

People tend to evaluate more and more information even when it doesn’t contribute to making a better decision.

You might keep reading Reddit posts, watching YouTube videos, and scrolling through Twitter, but will this really affect the probability of making a profitable investment?

How to avoid: understand that most commentary is useless and that often less information leads to better predictions.

22. Bandwagon effect

People might feel more comfortable doing something just because everybody else is doing it.

Everybody is buying this coin. This must be a good idea.”

How to avoid: do your own research and think independently. Remember that most people lose money, so stay committed to your plan to avoid getting suckered into poor investments when you see an asset skyrocket.

23. Disposition effect

Investors tend to sell winning assets too quickly and keep assets that are down for too long. This phenomenon is closely linked to loss aversion and other biases.

As a result, investors leave profits on the table and suffer greater losses by holding the bags instead of selling.

How to avoid: set targets for when to take profits and stop losses, and stick to your strategy.

24. Familiarity bias

Investors prefer to remain within the area that they know and avoid venturing out of their comfort zone.

You might have known Bitcoin for years, used it personally and understand how Proof of Work functions. For this reason you might avoid newer assets with different consensus algorithms that you’re not familiar with. As a result, you could become overexposed to the assets you know and miss new opportunities.

How to avoid: understand that a familiar asset is not necessarily less risky; make an effort to evaluate each new opportunity independently as if you did not have the prior information.

25. Restrain bias

This is the tendency to overestimate your own ability to control impulsive behaviour.

The line between trading and outright gambling is often very thin. When your trade is profitable, it’s tempting to double down on the winners and increase the position. Of course, this also leads to more risk.

How to avoid: define your risk limits by specifying the maximum position size as a percentage of your portfolio; ideally you should also specify limits for specific assets (e.g. small cap altcoins) and the volumes of long and short positions. This should help to minimise impulsive trading.

26. Survivorship bias

Talking to pilots who’ve returned from a dangerous mission alone won’t reveal all of the risks. Those who have perished are not there to tell their stories.

In the crypto market, the outstanding performance of Lambo-driving traders with 10x leverage is undoubtedly impressive. Yet there are far more of those who have lost their deposits and rarely talk about it on social media… and even if they do, hardly anyone follows them. This can lead to excessive optimism because failures are ignored or are not reported.

How to avoid: when evaluating instruments and opportunities, think of what is not being included in your selection – these omissions might be hiding risks.

Next steps

These are just some of the psychological biases that affect our thinking. Usually none of them exist in isolation and instead they interact in a myriad of ways that can cloud your judgement.

Bookmark this page and return to it from time to time. And if you can think of any other important biases to add, please get in touch with us on Twitter!

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