Understanding Behavioural Finance in Macro Trading

Trading in the forex market involves more than just technical analysis and fancy indicators. One of the most critical yet often overlooked aspects is the psychological element. Behavioural finance plays a crucial role in macro trading, influencing how traders perceive and react to market events. Understanding these psychological biases can significantly enhance your trading strategy and set you apart from the 90% of retail investors who fail within the first 90 days.

Join us as we explore common psychological biases and fallacies and how they can affect your trading decisions, as well as how to effectively manage motivation, fear, and greed.

Behavioural Finance & The Role of Psychology in Trading

The Psychological Element

Trading isn't just about numbers and charts; it's also about mindset. Professional traders understand that their psychological state can significantly impact their performance. Behavioural finance examines how emotions and cognitive biases influence financial decisions. For example, fear and greed are powerful emotions that can lead to impulsive decisions, often resulting in losses. Recognising these biases and learning to manage them is crucial for any trader aiming for long-term success.

Biases Affecting Trading Decisions

Biases affect how we perceive information and make decisions. Here are some common biases that can impact your trading:

Behavioural Finance & Common Psychological Biases in Trading

1. Survivorship Bias

Survivorship bias is the tendency to focus on successful traders and overlook those who have failed. This can create a skewed perception of what it takes to succeed in trading. For instance, media and educational resources often highlight the stories of successful traders while ignoring the many who did not make it. Macro traders avoid this bias by analysing their losing trades to learn from mistakes and improve their strategies. By understanding why a trade failed, they can adjust their approach and avoid repeating the same mistakes.

2. Confirmation Bias

Confirmation bias occurs when traders seek out information that confirms their existing beliefs and ignore contradictory evidence. This can lead to poor decision-making, as traders may overlook critical information that could impact their trades. For example, if a trader believes that a particular currency pair will rise, they might focus only on news that supports this view and dismiss any negative news. Macro traders counter this bias by objectively evaluating all information, even if it challenges their views. They understand that a well-rounded perspective is essential for making informed decisions.

3. Authority Bias

Authority bias is the tendency to attribute greater accuracy to the opinion of an authority figure and be more influenced by that opinion. This can be detrimental in trading when traders blindly follow the advice of supposed experts without conducting their own analysis. For example, a trader might take a position based solely on a recommendation from a famous market analyst. However, macro traders rely on their own analysis and strategies, ensuring they make informed decisions independently. They value expert opinions but always verify them against their own data and analysis.

4. Availability Bias

Availability bias occurs when traders make decisions based on the most readily available information rather than all relevant information. This often leads to an over-reliance on recent events or trends. For instance, if there has been a recent market crash, traders might become overly cautious, even if long-term indicators suggest stability. Macro traders focus on long-term probabilities and avoid being swayed by the latest news. They understand that the most recent information isn't always the most important and strive to consider a broader range of data in their decision-making process.

5. Hindsight Bias

Hindsight bias makes traders believe they predicted events better than they actually did. After an event has occurred, people often see it as having been predictable, despite there having been little or no objective basis for predicting it. For example, after a market downturn, traders might convince themselves that they saw it coming, even if they took no action to prepare for it. Macro traders use trading journals to objectively record their predictions and outcomes, helping them differentiate between skill and luck. This practice allows them to identify patterns in their decision-making and improve their strategies over time.

6. Outcome Bias

Outcome bias is the tendency to judge a decision based on its outcome rather than the quality of the decision at the time it was made. This can lead to misinterpretation of strategy effectiveness. For example, a trader might assume a strategy is sound simply because it has led to a few successful trades, without considering the underlying decision-making process. Macro traders assess the process leading to a trade, not just the result, ensuring continuous improvement in their strategies. They understand that even a well-executed strategy can sometimes result in losses and that learning from these experiences is crucial for long-term success.

7. Action Bias

The action bias drives traders to constantly act, even when patience would be more beneficial. This can lead to overtrading, where traders take positions just to feel active in the market. Successful macro traders know that sometimes the best action is to wait for the right opportunity. They practice patience and only enter trades when their analysis supports it, understanding that unnecessary actions can lead to significant losses.

8. Self-Serving Bias

Self-serving bias causes traders to attribute successes to their skills and failures to external factors. This can prevent traders from learning from their mistakes. For example, if a trade goes well, a trader might credit their expertise, but if it fails, they might blame market conditions. Macro traders recognise and learn from their mistakes, maintaining a balanced perspective. They understand that personal accountability is essential for growth and improvement in trading.

9. Association Bias

Association bias leads traders to link unrelated events. For instance, a trader might avoid a particular trade setup because of a bad experience in the past, even if the current situation is different. Macro traders rely on statistical analysis rather than emotional associations. They understand that each trading opportunity is unique and should be evaluated on its own merits.

10. Contagion Bias

Contagion bias occurs when traders let their emotions from one experience affect their decisions in unrelated situations. This can lead to irrational decisions based on emotional responses rather than logical analysis. Macro traders keep their emotions in check and stick to logical, tested strategies. They recognise that emotional decision-making can lead to poor outcomes and strive to remain objective.

11. Information Bias

Believing that more information leads to better decisions is a fallacy. Too much information can overwhelm traders and lead to analysis paralysis. Macro traders focus on relevant data and avoid overloading themselves with unnecessary information. They understand that having a clear, focused analysis is more effective than being inundated with data.

12. In-Group-Out-Group Bias

This bias leads traders to follow the crowd, often resulting in herd behaviour. Macro traders stay objective and follow their own strategies, even if it means going against popular opinion. They understand that following the crowd can lead to missed opportunities and potential losses.

Psychological Fallacies in Macro Trading

1. The Conjunction Fallacy

Traders often believe that more indicators mean better predictions. This can lead to an overcomplicated analysis process and missed opportunities. In reality, simplicity and intuition often yield better results. Macro traders use a streamlined approach, focusing on a few key indicators and relying on their experience and intuition to make decisions.

2. The Sunk Cost Fallacy

This fallacy involves irrationally trying to recover past losses. For example, a trader might continue to invest in a losing position because they have already invested a significant amount of money. Macro traders stick to their strategies and avoid making emotional decisions based on previous trades. They understand that past costs are irrelevant to future decisions and focus on making the best possible choice based on current information.

3. The Gamblers Fallacy

Believing that past outcomes influence future probabilities is a mistake. For example, a trader might believe that after a series of losses, a win is due. Macro traders understand that wins and losses are randomly distributed and that each trade is an independent event. They base their decisions on probability and analysis rather than superstition.

4. Self-Awareness in Trading

Self-awareness helps traders recognise their biases and adjust their behaviour. Knowing when to take a break and maintaining a balanced approach is crucial for long-term success. Macro traders understand the importance of mental and emotional health in trading and ensure they take care of themselves to remain sharp and effective.

Motivation, Fear, and Greed

Staying Motivated

Maintaining motivation can be challenging, especially during losing streaks. Macro traders set realistic goals and use incentives to stay focused on their long-term objectives. They understand that trading is a marathon, not a sprint, and that consistent effort over time leads to success.

Managing Fear and Greed

Fear of losing and greed for quick profits can cripple a trader. These emotions can lead to impulsive decisions and significant losses. Macro traders manage these emotions by following a well-defined strategy and investing amounts they can afford to lose. They understand that maintaining discipline and sticking to their plan is essential for long-term success.

The Importance of Patience

Patience is a rare but essential trait in trading. Avoiding the fear of missing out (FOMO) and waiting for the right opportunities can lead to more successful trades in the long run. Macro traders understand that good opportunities are worth waiting for and that rushing into trades can lead to poor decisions and losses.

Understanding and managing psychological biases is a crucial aspect of successful macro trading. By recognising these biases and adopting strategies to mitigate their effects, you can improve your decision-making process and enhance your trading performance. At Logikfx, we provide resources and tools to help you master behavioural finance in macro trading. Watch our FREE Online trading class here!