Forex Trading and Behavioral Economics -
Exploring the Influence of Behavioral Biases
on Currency Markets
With the rapid expansion of technology and the increased availability and accessibility of the internet, things such as Forex Trading have become a global phenomenon.
Millions of investors access the Forex market, which has never been easier. The large number of users brings unpredictable side effects that shape the market.
The field of study that researches this is called behavioral economics.
It delves into the psychology of the masses and how individual thinking leads to trends that change the trajectory of the whole Forex market.
The Most Essential Skills for Forex Traders
Traders require many skills to turn a profit in the competitive and fast-paced forex market. Many things make a successful trader.
Things like experience, motivation, and discipline are all important but not as crucial as managing emotions.
If traders can manage their emotions confidently, nothing comes close to what they can achieve. Since stable behavior is the foundation for developing any skill, newer or experienced investors should focus on improving behavior before focusing on anything else.
Managing emotions is much easier if you have a trustworthy broker. It is one less thing to worry about and gives you peace of mind.
One such brokerage is https://justmarkets.com which gives traders a trusted and professional Forex Trading experience.
Behavioral Biases as a Skill in Forex
People have specific behavioral patterns shared amongst 90% of the human race—decisions about mundane tasks or trading can be influenced by emotion and often be irrational. We often make choices on impulse and without much thought.
Biases stem from the many misconceptions that people have about things. They are used to make decisions quickly but can lead to a bad outcome.
Mastering emotions and overcoming biases are any trader's most essential skill. Consequently, in the following section of the article, we will go over the most common biases so that you can understand and avoid them.
When researching something that already has a theory, it is easy to look for proof of our approach and ignore facts that would say otherwise. This is called confirmation bias.
In trading, users tend to search for information that would support their current standing. This bias can lead to the trader making a mistake because he hadn’t reviewed his position objectively. When choosing a trade, we must view all sides before locking in on it.
This bias is most famously accompanied by an example such as the Dunning-Kruger effect, where people who are not skilled at a particular field have more confidence than those who are almost or already experts at it.
Traders often overestimate their skills and knowledge and make decisions based on previous wins. They put less time and effort into making a decision and make a mistake. No matter the trader's experience, sufficient research should always be done.
This bias stems from gambling when people make assumptions about future outcomes based on past results.
Gamblers like to think that their bad luck is running out, and they expect a win. Casinos make a profit from this mentality.
An example of a gambler’s fallacy is when traders expect a particular currency to go up because it has been going down for a long time.
Herd mentality appears in communities with many users when people decide based on how the majority acts. For example, when a large group of traders makes a particular decision, people are bound to follow in their steps without giving it much thought.
Sometimes a decision of the “herd” can be correct, but often by the time the information reaches the average trader, it can already be too late.
This bias causes significant market trends, also called the bandwagon effect. It is considered one of the worst biases in the Forex Market.
It is logical that, more often than not, readily available things are more used than those not. People like to take the easy route, so they usually do not research enough.
Traders often base their trades on readily available information and do not try to inform themselves thoroughly. This approach based on preliminary research often results in the only information that is found to be very recent and possibly untrue. Traders can overvalue recent details and make the wrong decision as a result.
How significant is the influence of behavioral biases on the currency market?
In a word, massive. It could be argued that these biases are integral to the Forex Market. They influence it daily and for billions of dollars. A trader cannot simply ignore them as they are genuine.
With the introduction of many third-world countries to the internet, the Foreign Exchange market is bound to have a more extensive user base and many people who are not experienced traders. These new traders are bound to be influenced by these behavioral biases.
Biases are here to stay. People are imperfect beings. As long as people use the market, the imperfections are there to follow.
This circles back to how emotional instability influences people in the forex market. It is a valuable skill that differentiates between good and bad traders.
How to avoid biases and make intelligent decisions?
The answer is research and lots of it. Traders need to check if they are falling into a bias manually first. Check whether the decision will be influenced by something irrational.
Is there something you haven’t found out? Have you looked at every indicator? What is the market currently doing? What do experienced traders think?
Lastly, why are you making that decision? What were you influenced by? Think about these questions, and their answers will surely bring you one step closer to succeeding, and what is more, you will be a better trader.
Trading is a whole field by itself, which is very complex and fast-paced. As the article discusses, it is influenced by many things, including behavioral economics. We named a few significant biases, their significance, and how to avoid them.
In the end, biases will continue to affect the market, and a part of a trader’s job is to make decisions with preferences in mind.