Cognitive dissonance in the markets

cognitive dissonanceCognitive dissonance is a psychological condition in which individuals that hold certain beliefs end up acting in a completely contrary manner to them. This is a condition that’s particularly prevalent in the markets. There may often be clear, valid reasoning for selling a certain stock because of a major scandal related to it and yet, traders can choose to keep it. Common arguments include saying “the market will go back up” or that “this is just media manipulation”.

This can happen in face of compelling, even irrefutable evidence, and can turn a winning trade or even a fortune into ashes. Researches have discovered a lot in the area of psychology of trading. Yet, traders still struggle with cognitive dissonance in the markets. Worse yet, traders often know they are in the wrong and persist in damaging their portfolio. The difficulty lies in accepting the obvious because of the need in believing in a different reality.

The trap of cognitive dissonance in the markets

We mentioned before in our article about trading traps that investors can often for certain habits due to stress and other psychological factors. We can readily understand that confidence often breeds carelessness but what other compelling reasons can there be for, let’s say, betting against the market?

Science is still far from discovering the full intricacies of the human mind. A lot has been achieved but the full spectrum of thought processes is still beyond us. Yet, what distinguishes good traders from best? The answer is simple. In 2 words: Good consciousness.

Good consciousness comes from anticipating certain outcomes particularly the ones that are obvious and keeping a rational, cool demeanor. It demands effort and clarity of the mind. Good consciousness allows traders to take profit when it’s time and stop loss when they are wrong. It’s important to know there are 2 main causes for cognitive dissonance in the markets.

balance-716342_1920The first one is stress, as has already been mentioned in our article “The proper mind framework when trading”. Professional traders know when they are stressed and know when to take a time out from trading. Stress eventually manifests in a streak of losing trades or simply lack of focus. Other factors can also contribute to worsening this condition, which can manifest in the vain, empty belief that a certain stock will rise for no good, logical reason. Stressed players make bad decisions.

The second cause for cognitive dissonance is ego. Many traders are often guilty of the so-called “revenge trading”. This is a type of emotional decision based on frustration of lost time or money. While in a state of fury, traders can blame the market, the other traders, the companies or the state, but never themselves. This is also a form of cognitive dissonance in the markets and, of course, must be treated fast.

Take breaks often

Both stress and ego can bring in cognitive dissonance and they are all interrelated with each other. As a trader, you should know the limits of your mind. Make periodic self-assessment to determine when you can’t trade anymore and take one or even two days off from trading. This doesn’t mean you need shut yourself off the market completely. You can (and should) read more about trading and the markets, and keep yourself informed, if possible, also seeking advice.

Tradeo advises traders to know their condition before trading and take breaks when hitting a certain loss limit to reassess their strategy. These small steps can go a long way in ensuring better trading.

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