Trading Biases – Illusion of control


Before the arrival of COVID-19, we all felt that we had complete control over our life. College graduates planned to start their corporate career or attend a new college to do their post graduation, a family had its vacation bookings confirmed in Paris; and see what happened. Life is very unpredictable. One cannot predict what happens in the future with 100% certainty.

All traders and investors have been through this phase when they try to predict things. When I got introduced to technical indicators, I often used to tell my friends how I can easily predict prices and also used to tell them to buy a particular stock as it showed a buy signal in one of the many indicators that I was using.

Now when I look back, I realized that I had this illusion that I can control prices in the market which of course nobody can. This was due to my extraordinary belief in indicators that it has to be always right. I used to think that it was a rational decision as I used some logic to come at a conclusion, completely ignoring the role of chance.

The Bias

Let us take some real life examples to understand the bias.

Let us say you went to buy a lottery ticket. You spent hours looking at the numbers on the lottery ticket as to which one would help us win the grand prize. Mathematically speaking, the probability of winning the grand prize is same whether one spends hours searching for the best lottery ticket or randomly selecting one. The choice of selecting a lottery ticket number gives us an illusion that we can control the outcome.

Consider two situations:

  1. Your friend driving a car and you are sitting besides
  2. You are driving a car and your friend is sitting besides

In which situation, do you think there are less chances of accidents(given that both of you know how to drive a car with same driving skill)?

The majority would go with the second option when they themselves are driving because of the fact that they are in control of the steering and thus less prone to accident. Of course, you can control the chances of accident to a fair degree given your driving skills but you cannot avoid it completely because a lot of that depends on other drivers on the road too. Again, the probability is same in both the cases but you are under the illusion that since the steering is in your hands, nothing can go wrong.

Illusion of control in Stock Market

Lottery example is a lot similar(I do not say that stock selection is exactly like choosing a lottery ticket) to the stock selection for investing. One carries out the Fundamental analysis of the stock, reads annual financial statements of last 10 years, looks at the products, revenue, EBITDA, PAT, etc before investing into a particular stock.

The research that you did to select the stock makes you believe that nothing can go wrong with this company as the stock met each criteria for a successful Multibagger. But, the fact remains the same. One cannot control the management’s decisions, the state of the economy, government actions and many more such factors that directly or indirectly affect the business and eventually the stock price.

In trading too, we get this illusion of control when we use combination of complex technical indicators to arrive at a conclusion of going long or short. We tend to believe that because we have done such a complex job of analyzing the price, we cannot be wrong and everything will go according to our plan.

Trading and investing are probabilistic and not deterministic. The experience in market isn’t a measure of how successfully one can trade or invest because markets don’t care whether you are an experienced ace investor or a naive new comer.

However, experience gives an edge when one truly understands these illusions/biases and never blames markets for losses or boast off skills when making string of profits. The following quote summarizes the entire plot of the article.

We are prone to overestimating our part in success and underestimating it in our failures, ignoring the role of chance – Ellen Langer

That’s it for today.

Stay Tuned!

How useful was this post?

Click on a star to rate it!

Average rating 5 / 5. Vote count: 1

No votes so far! Be the first to rate this post.

Spread the love

About the author

Akshay Satpaise

Akshay Satpaise is an Electrical Engineer who loves data crunching. He has interests in personal finance, stock market and data analysis.

View all posts

Leave a Reply

Your email address will not be published.