Why Trading Failure Is In Our DNA And How To Fix It - (2024)

Every trader knows this scenario: you found a great setup and entered a trade, then price goes against you and you buy more because you believe that price will still go up. And as price goes down further, you keep buying until you are left with a huge loss and have to close your position because it hurts too much. Been there, done that.

But why does it feel so good to add to a loser and why can’t we as traders just not stop doing it?

Cognitive dissonance 101 – Your brain is not made for trading

The mechanism that is driving such destructive behavior is called “Cognitive Dissonance” and it is an internal protection mechanism that we humans have developed to create a comfortable reality around our daily lives. Cognitive Dissonance is so deeply rooted in our DNA that it controls many of our actions and most of our live.

Cognitive dissonance means that we are experiencing conflicting and discomforting experiences, thoughts and emotions that arise from our own actions. A popular example are smokers who are faced with the dangers of getting cancer – it’s easy to see why smokers don’t like to think of cancer 20 times per day each time they light a cigarette. When people experience such negative emotions, they start to change their behavior and/or their thoughts to reduce the discomfort. But instead of quitting smoking, smokers will justify their bad behavior, talk down the risks or come up with other avoiding mechanisms to make them feel better. You can probably already see how this will apply to trading problems…

There are two types of cognitive dissonance biases:

1) Selective perception: people only notice information that appears to affirm a chosen course.

Suddenly people only read confirming articles or talk to people who share their ideas in order reduce the dissonance.

In trading, people only look for articles or use indicators that justify staying in a losing trade. Or, when you are in a losing long trade, you give too much weight to every uptick and you neglect the fact that price keeps going down and down.

2) Selective decision making: people rationalize actions in order to stick to an original course.

“Everyone does that, so why not me?” is a term often used to justify bad behavior. This rationalizing starts as early as kindergarten, we do it throughout school, university, it’s common in workplaces and also in our family lives…

In trading, people try to come up with excuses why adding to a loser is good or why they should break their entry rules this time (again).

Popular everyday examples of Cognitive Dissonance

Cognitive dissonance drives almost all our behavior and daily actions, usually without us knowing it. Without cognitive dissonance we would feel terrible and worried all the time because we’d have to face the cold hard truths and effects that our own decisions are bringing us. In order to avoid those unpleasant emotions, people go to great lengths to avoid admitting the inconvenient truth:

• With the “purchase justification” we convince ourselves that something we bought isn’t “that bad after all” even though we probably don’t need it and spent too much money.
• When we tell ourselves that the work that we are doing is actually meaningful and that “it could be much worse”, even though you had to give up on your childhood dream.
• Our bad grades on a test, not getting the promotion or having an accident must besomeone else’s fault, not yours. Of course!
• Lance Armstrong convincing himself that it’s ok to keep doping because he is doing so many good things that are only possible because he wins.
• All advertisem*nt is aimed at reducing our cognitive dissonance through targeting indecisiveness and worries that we have before making a purchase.

“Every time you are tempted to react in the same old way, ask if you want to be a prisoner of the past or a pioneer of the future.” –Deepak Chopra

Cognitive dissonance in trading

Cognitive dissonance has many forms in trading and it influences all layers of our decision making as traders:

• Traders add to losers as a protection mechanism and to show that they believe in their original trade idea: “I am right, price will turn around and now I can buy cheaper…”
• When traders make a one-sided market analysis and then are too convinced that they “know” where price will go. Then they won’t see information that they are wrong.
• When you openly discuss trades and positions you are more likely to justify bad trades and defend your losses – and stay in them longer.
• When you are still losing money after 5, 6 or 7 years but you still file it under ‘learning process’ or ‘market tuition’.
• When you try to come up with excuses why breaking your entry rules, chasing price or using too much risk is a good thing.
• When you only look for ticks in the direction of your trade and don’t see the whole picture.

And even when it comes to the price action you see on your charts, cognitive dissonance is often the driving force behind fake breakouts, fakeouts and unreasonably volatile market tops where amateurs are tricked into taking more losing trades and are then forced out of their huge losses.

False breakouts are the manifestation of cognitively dissonant traders.

Reducing cognitive dissonance in trading

There is no ‘easy trick’ that will suddenly turn off the problems that come with cognitive dissonance – we have developed this mechanism over thousands of years – but there are a few very specific things and ways of thinking that a trader needs to adopt in order to make better trading decisions:

• Don’t talk about (and never justify) a trade to anyone else. When we talk about trades, we easily get our ego involved and we don’t want to show that we are in a losing trade. Amateur traders who openly share their trades are much more likely to talk themselves into staying in losing trades longer because they come up with reasons why a trade is still good.
• When creating a trading plan, always come up with long AND short trading scenarios. Avoid one-sided analyses to keep your mind and eyes open to both sides of the market.
• Keep a trading journal to raise awareness for your trading behavior. A trader who tracks his behavior can see how much he is losing by repeating the same mistakes and is then more likely to change his behavior.
• Be humble! Accept that you don’t know everything and that you will frequently encounter losses. A trader who can’t take a loss, has no chance of becoming a professional full-time trader.
• When taking a trade, always explain to yourself loudly in words, as if you had to explain to someone else, WHY this particular trade makes a lot of sense and fits your trading plan. You will very quickly notice whether you are bullsh*tting yourself or not.

Our mind really deserves to be called the great trickster. Controlling it requires us to first become aware of it and of the ways in which it manipulates us in our behavior, especially when it comes to trading. Understanding the concept of cognitive dissonance is a critical step in reaching a truly objective assessment of one’s self-performance and abilities.

“We’re blind to our blindness. We have very little idea of how little we know. We’re not designed to.”