{"id":94881,"date":"2016-09-05T18:03:43","date_gmt":"2016-09-05T22:03:43","guid":{"rendered":"http:\/\/countingpips.com\/?p=94881"},"modified":"2016-08-28T18:04:08","modified_gmt":"2016-08-28T22:04:08","slug":"how-the-sunk-cost-fallacy-can-derail-your-trading","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2016\/09\/how-the-sunk-cost-fallacy-can-derail-your-trading\/","title":{"rendered":"How the sunk cost fallacy can derail your trading"},"content":{"rendered":"
September 5, 2016<\/div>
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By Admiral Markets<\/b><\/p>\n

\"pablo<\/p>\n

Dear Traders,<\/p>\n

Did you ever hold on to a trade, even though a loss seemed likely?<\/p>\n

Well, don’t worry:<\/p>\n

…you are not alone.<\/p>\n

All traders are victims of this problem at some stage – so much so, that it has it’s own name i.e. sunk cost bias.<\/p>

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The sunk cost bias explains why humans tend to commit to past decisions, over the best future benefit.<\/p>\n

This problem can cause havoc for your trading account.<\/p>\n

The good news is, I’m here to help you fight this trading weakness.<\/p>\n

Not only will this post explain why traders stick to bad decisions:<\/p>\n

…it will also provide clear steps on how to change your thinking and become more rational in your choices.<\/p>\n

\"Advanced<\/a><\/p>\n

What is sunk cost fallacy?<\/h2>\n

Renowned entrepreneur Rolf Dobelli did a great job of explaining the sunk cost bias, in his book
\nThe Art of Thinking Clearly<\/em>.<\/p>\n

I’ll try to summarise his findings.<\/p>\n

Basically, he says it all comes down to human nature.<\/p>\n

Traders are human beings first, so they tend to justify their decisions using past events.<\/p>\n

Let me give you an example.<\/p>\n

Do you ever keep stuff like papers or clothing, even though you know you will never use them again?<\/p>\n

Or maybe you have a struggling project that requires more and more resources, despite the low odds of success?<\/p>\n

Both situations are textbook examples of the sunk cost bias.<\/p>\n

Our inability to let past things go, clouds our judgement and makes it difficult to take action.<\/p>\n

For traders, this bias translates into focusing on past costs and efforts, when making current trading decisions.<\/p>\n

In short, the sunk cost fallacy explains why some traders:<\/p>\n

    \n
  1. rely on luck<\/li>\n
  2. tend to ignore new information<\/li>\n
  3. find it difficult to accept even a small loss.<\/li>\n<\/ol>\n

    Does sunk cost fallacy impact your trading?<\/h2>\n

    Short answer – yes.<\/p>\n

    Traders refer to sunk cost bias as
    \nthrowing good money after bad money.<\/em><\/p>\n

    Again, it means traders hold on to a trade because they are not willing to change their view and accept a loss.<\/p>\n

    Traders struggle with sunk cost because they:<\/p>\n

      \n
    1. have a strong sense of avoiding losses<\/li>\n
    2. create a commitment to an open trade setup<\/li>\n
    3. exaggerate potential benefits from their open trades<\/li>\n
    4. want to prove that their initial decision made sense<\/li>\n
    5. prefer not to admit that a trade was a waste of time<\/li>\n
    6. fear regret<\/li>\n
    7. ignore the potential opportunities<\/li>\n
    8. have unrealistic profit expectations<\/li>\n
    9. think their image will suffer if they change their decision too soon.<\/li>\n<\/ol>\n

      The above reasons explain why proper trade management and exit management, are such a difficult part of trading.<\/p>\n

      Incidentally, if you have been to our
      \n      live webinars<\/a> then you probably already know that Nenad and I often mention this issue.<\/p>\n

      \"pablo<\/p>\n

      How to avoid the sunk cost fallacy?<\/h2>\n

      Psychological blocks are by far the hardest things to overcome.<\/p>\n

      But there is good news:<\/p>\n

      …you can significantly reduce sunk cost bias\u2026<\/p>\n

      …if you become consciously aware of this fallacy.<\/p>\n

      There are many ways to improve your awareness.<\/p>\n

      You can try meditation, breathing exercises or slowing down your decision-making process.<\/p>\n

      Quick decision making is often an enemy of critical thinking.<\/p>\n

      Additionally, there are questions you need to ask yourself.<\/p>\n

        \n
      1. What would I recommend to a friend if they were in the same trade?<\/li>\n
      2. Am I sacrificing other good trading opportunities that I’m not aware of?<\/li>\n
      3. Have the parameters of the trade setup changed?<\/li>\n
      4. Is there new information that makes the trade less desirable?<\/li>\n
      5. Am I simply trying to prove myself right and the market wrong?<\/li>\n<\/ol>\n

        After all, optimal trade management is just a matter of asking the right question at the right time.<\/p>\n

        Don’t get me wrong, I am not advocating closing trades on every emotional whim.<\/p>\n

        But it goes without saying that traders should formulate their own trade management plan.<\/p>\n

        This plan should help remove past fears and make you more focused on future benefits.<\/p>\n

        For starters, take a look at our video below to learn more about profit stops.<\/p>\n