People in the foreign exchange market use the term “recency bias” a lot, so I thought it would be interesting to talk about it.
But first, what does “recency bias” mean when it comes to forex trading?
Recency bias is the tendency for traders to only look at the most recent events and ignore older but just as important (or sometimes even more important) pieces of information.
Recency bias hurts a trader’s ability to analyze the market because it clouds his judgment and makes him less good at making decisions.
Most of the time, recency bias shows up in forex trading when a trader only looks at his most recent trades and loses sight of the bigger picture.
An example of this is a fundamental trader who gives too much weight to a recent economic event and doesn’t look at the bigger macroeconomic picture.
A technical trader who puts a lot of weight on newly formed candles and loses track of long-term trends is another example.
It also has a psychological side to it. Say there are two people who trade.
Mike has won his last three trades. Overall, he has won 4 trades and lost 6 trades. Mike’s account has grown by 1% so far this year.
John, on the other hand, has lost his last three trades. John has won 8 games and lost 7 games so far this year. His account balance is up 5% so far. Mike is giving himself high-fives because he has won five games in a row, while John is feeling sad.
But if you look at the big picture, you’ll see that John is actually ahead. He has won more games than he has lost, and his percentage gain is also much higher than Mike’s.
Mike and John could be affected by recency bias if they think too much about their most recent trades. This could affect how they trade in the future.
Mike could end up ignoring possible warning signs and rushing into a trade, while John could get frustrated, stop following his rules for risk management, and start trading too much. Both of these situations are clearly bad.
Do either of these (or situations like them) happen to you often? If you do, here are some ways to avoid being affected by recency bias:
Keep a detailed record of your forex trades.
As we’ve talked about, keeping a detailed trading journal is almost as good as having a coach keep track of your forex trade decisions over your shoulder.
By keeping track of your progress and the right and wrong moves you’ve made, you’ll be able to see how you’re doing in forex trading as a whole instead of just focusing on your most recent trades.
Write down your plan for trading and make sure you follow it.
If it will help, you can make a list of all the things that need to be true before you enter a trade. This way, you’d be less likely to let your emotions get in the way of your trading plan, whether you’re feeling overconfident after a string of wins or more hesitant after a trading slump. Instead, you’d be more focused on following your trading plan.
Practice in a planned way.
Keep in mind that deliberate practice can help you remember why you made your trade plan and why it works.
Practice can also help you keep up with what’s going on in the market and let you make changes to your trade plan if you need to.
By doing this, you’ll be able to look at the big picture and evaluate how well you’re doing in trading at the same time. That’s a great way to kill two birds with one stone.
Pay attention to how you feel.
One of the best ways to avoid recency bias is to pay attention to how you feel. If you think you might give in to your emotions, take a step back and try to look at your past trades with more objectivity.
If your losing streak is making you feel bad, you might need to take a break from trading or a short trip.
For some traders, the trick is to talk to themselves or talk out loud while trading. What matters is that you figure out what works best for you.
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- Warren Buffett
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