Are you sabotaging your crypto trades? A look at the hidden biases distorting decision-making  

You’ve created the perfect strategy and backtested it. You have a real edge and robust risk management. Yet, you’re losing money when trading crypto. That’s because, unlike what you may believe, the biggest threat to your trading account isn’t in the market: it’s in your own head. Cognitive biases hardwired into your brain are the silent killer of your trades, and chances are, you may not even be aware that you’re sabotaging yourself.  

You aren’t the first and certainly not the last to struggle with this. Many traders believe they act rationally, but in fact, human decision-making is full of hidden psychological traps that even the most experienced traders can fall into. The truth is, many people don’t think about the psychological aspects of trading when they dive into cryptocurrencies. They read a bit about the market, check the price of the top cryptocurrency on a reliable platform like Binance, and buy it in hopes of making a profit. But soon after, they realize crypto moves fast and hits hard. When volatility gets wild, they start to panic and make impulsive decisions that, as one would expect, have disastrous consequences. The good news is that it’s possible to avoid this outcome, and it all starts with recognizing the cognitive biases that impact traders’ thinking in the first place.

Confirmation bias

This refers to the tendency of human beings to seek out information that they already believe and to ignore whatever contradicts it. This is a phenomenon that had first been documented millennia ago in “The History of the Peloponnesian”, but it wasn’t formalized until the 1960s. Confirmation bias is the motor of echo chambers formed in the online world by algorithms powering social media platforms. To retain users’ attention, algorithms push content they’ve previously consumed, creating echo chambers where people continue to be exposed to opinions and ideas that reinforce the beliefs they already hold.

Let’s say someone is bullish on cryptocurrency, reads crypto publications, and spends their time on crypto communities echoing this sentiment.  This person dismisses opposing viewpoints and doesn’t want to engage with sources that might offer an overall picture of cryptocurrency’s strengths and weaknesses. In this scenario, this individual becomes entrenched in their beliefs and therefore interprets every piece of information through the lens of confirmation bias.

Availability bias

This refers to people’s assessment of an event’s likelihood based on how easily an example comes to mind, just as anecdotal evidence can more strongly negate or support beliefs than actual research. This could lead to overestimating the likelihood of drastic events like a shark attack or a plane crash, although they are less frequent than other risks (such as road accidents), which are more memorable.

In the crypto trading world, availability bias happens when traders react to market trends or recent news that are dramatic or vivid, whether major earnings misses or a market crash, leading to a disregard for adequate risk management or impulsive behavior. For example, a trader assumes that a popular digital asset will continue to rise in price, rather than relying on comprehensive research to inform their investment decision, which eventually leads to losses when the token crashes (which could have been avoided).

Anchoring bias

This is a psychological phenomenon in which you rely too heavily on a piece of information that acts as an anchor. Once this anchor is set, you compare all information against it, and even anticipate outcomes based on this reference point, which ultimately distorts perception and leads to biased decisions, especially if the anchor is either misleading or irrelevant.

For example, let’s take the milestone of Bitcoin price hitting $100,000 for the first time. This event could have become an anchor for a trader, shaping their expectations about the future performance of the crypto. Therefore, instead of objectively evaluating new information about the digital asset, they interpret subsequent price movements based on that milestone, assuming the price is only bound to keep rising once it reaches that target (which, as has already been proven, is not the case).  

Loss aversion

Humans are wired to feel losses more intensely than gains. There is an element of self-preservation here, but in crypto trading, there’s no choice but to risk it to get the biscuit. Unfortunately, many traders sell low during market downturns because the pain of watching their portfolio shrink is just unbearable.

Let’s take the example of a trader whom we will call Dean. Dean purchased Ethereum at about US$4600 in November of 2021, but when the price had fallen to US$1,065, he sold because he couldn’t handle the stress. However, when Ethereum was trading above US$4,000, Dean had many regrets because he acted out of fear, which turned out to be a huge disadvantage.  

Overconfidence bias

Cryptocurrency markets thrive on speculation, which can lead traders to feel overconfident about their trades. For example, after initial success, newcomers may assume they’ve cracked the code but later face devastating losses.

This cognitive bias blinds traders to risk and encourages reckless behavior, like borrowing money to boost the size of a trade or neglecting stop-loss orders. Overconfidence bias is a serious flaw because it can lead traders to take larger positions than is wise and, therefore, lose money more quickly.

How to mitigate cognitive biases in crypto trading

Okay, you are aware of the most common cognitive biases in crypto trading, but what can you actually do to mitigate them? Here are a few strategies to keep in mind:

• Have a strategy. A well-defined trading plan helps you navigate market volatility, stay focused on your vision and goals, and potentially achieve consistent profits over time.
• Commit to continuous learning. In the crypto sphere, there is always more to learn, so it’s important to educate yourself constantly by following credible news sources, studying economic principles, and researching blockchain technology.
• Seek different perspectives. Even if you are very enthusiastic about crypto, it can help to confront yourself with opposing opinions because it will give you a more complete understanding, foster intellectual resilience, and strengthen your ability to make balanced decisions.
• Learn from successes and mistakes alike. Reflection is one of the best tools for improving decision-making in crypto, enabling you to extract valuable lessons. By systematically assessing past actions, you can reduce the impact of cognitive biases that distort judgment so often.

The bottom line

The world of cryptocurrency trading is as much a psychological battle as it is a financial one. Staying aware of the cognitive biases that can lead to irrational decisions can help you take a step back and take aligned action that will improve your chances of success.