The market’s nature is unpredictable without any doubt. However the every trader experiences losses and profits. As a result these profits and loss are the part of the probability. Meanwhile there are some trader who gains confidence after the some few profitable trade. Some traders feels like they are losing their confidence when they gone through some losing trade’s streak. These nature of the traders are known as the recency bias in trading.
Recency bias focuses on the recent events more while ignoring the bigger picture. Meanwhile they start evaluating their trading performance on the last trade outcome rather than the large sample of trades.
Having the awareness about these trading terms may increase the discipline and make better long term decision.
What Is Recency Bias?
When a trader feel more tilted towards the latest experience instead of treating the old and new experience equally. However this tricks the brain by assuming that bearish or bullish will continue forever. Meanwhile this causes the trade buy asset at the peak and sell at the bottom. Instead of looking at the long term perspective they let recent wins or losses influence their future decision.
How Recency Bias Hurts Traders
Buying the Top / Chasing Bubbles: In recency bias traders often believe what they are currently seeing in the markets. They don’t look at historic price actions and charts of that particular asset. Once they see a stock continuing to show the bullish momentum from the last few days and they believe it will continue it’s trend. Later on they ends up entering late in the rally of trade.
Panic Selling: When a stock completes it rally and come down for the correction, recency bias often creates fear. Amid this correction traders often forgets to look at the past data of an asset. In the view of avoiding the loss they start selling their positions in a panic.
Abandoning the Trading Plan: Traders heavily influenced by the short term money making opportunities in the market. This opportunities often forces traders to abandon their trading rules in the hope grabbing the opportunities.
How Recency Bias Appears in Trading
When a trader faces five or more consecutive wins, they start believing that their strategy can’t fail, i have understood the market movements, i should react to the every market moment etc, that’s why the traders start give more importance to the recent experiences. Due to this cognitive thinking traders let their emotions influence their decision.
Behavioral Traps Of Recency Bias
Chasing the Rally (Buying the Top): When an asset start moving due to the any news, traders jumps in the rally out of the fomo. Meanwhile traders start assuming that these upward trend will continue forward. But later on they finds out they entered at the peak.
Overconfidence After a Hot Streak: Few continuous winning trade may distort the traders risk perception. Feeling of the high excitement, joy, increasing position sizing, avoiding the stop loss and working outside their trading plan.
Hyper-Fixation on Recent Candles: Many traders give excessive importance to the last candlestick. Meanwhile they ignore the broader time frame’s support and resistance area.
How Recency Bias Hurts Trading Performance
Recency bias depends heavily on the recent trades or current market conditions. Meanwhile it hurts trading performance by forcing the trader to make irrational decision. Examples panic selling during the short term correction period, chasing the asset at the peak and abandoning the strategy in the early stage.
How Recency Bias Manifests in Trading
Chasing Hot Trends: Traders often engage with the trade which has recently surged. By overestimating the recent winning trades, they buy an asset at the high valuations, just before the trend reverse, correction or the price drops.
Panic Selling and Overreacting: Amid the sudden manipulation in the market towards any side. Traders believe that bleeding won’t stop from now. As a result they start selling the positions at bottoms of the markets. When the reverse from the bottom they feel fomo of seeing the market moving in their direction. Meanwhile this leads to abandon their pre defined entry and exit criteria.
Prematurely Closing Winners: When a trader faces back to back losing trades in a row. When a trade which finally moves in their favor then book their position very early and later on they see that trade is hitting their target.
Why Professional Traders Avoid Recency Bias
Pro traders avoid engaging with the recency bias because the know that this will lead to the abandoning their trading rules set. By over reviewing the trade, dropping off the well test profitable strategy after the few losses. Taking impulsive trades, chasing the markets etc.
How It May Impacts the Pro Traders Performance
Overestimating Risk After Losses: After the few consecutive losses traders start believing that the existing has stopped performing and etc. Even the some traders abandon their 60% historic win rate strategy. As a result it causes the trader to leave the current system and start looking for another profitable system.
Reckless Overconfidence: A back to back few wins traders start believing that the have mastered the markets. But in reality nobody can master the markets. They think that anytime they can trade and make money and the everytime the conditions will be favorable to them.
Chasing Momentum: Beginner traders often enters in the trade when they are at their peak. They believe that the momentum will continue further. As a result it leads to ignore the long term bias and structure of the market.
Practical Ways to Overcome Recency Bias
Log Setup & Emotion: Write down the points why you entered in the trade. Any emotions or mistakes involved while taking the trade.
Track Statistical Metrics: Rather than focusing on the earning amount. Track the average risk to reward ratio of the strategy, win rate. Under which conditions trade gives more than the average risk to reward ratio etc.
Use Strict Entry/Exit Checklists: Enter only in the trade when the risk management criteria are met.
Standardize Risk per Trade: Set the predefined risk for the every trade which should be according to the trading account capital size. It isn’t should be more than 1-2% of the total trading capital.
Fix Trade Limits: Make a rule whether the trade may lose or win. I won’t take more than the 2-3 trades per day.
Conclusion Lines
Recency bias factor is one of most dangerous psychological factors in the trading. While it may look dangerous as the overtrading and revenge trading. But damages the trading performance slowly slowly.
The market doesn’t care about the last trade result. It only rewards the flawless execution on the proven and the backtested strategy.
Recognize and managing about the recency bias in trading. May structure the trading in the disciplined way.