Trading Cognitive Bias - Ambiguity Effect

In this post, I describe and explain how to deal with the trading cognitive bias - Ambiguity Effect. This bias is the tendency to avoid options for which missing information makes the probability of a particular outcome seem "unknown."

Sooooo... It's kinda hard to be a trader if you suffer from this little bias. Trading is defined by making the best decision possible with imperfect information... in other words, making the best decision you can under ambiguous circumstances.
As a trader, you know going in that you won't have all the facts. That you can't have all the facts. If you have the facts already, then the market has them already. And if the market has them already, the only way you make money is if the market's perception of the facts is wrong... and yours is right... consistently.
I can tell you from very painful experience, it's nearly impossible to outsmart market perception consistently... especially over time. You're much better off going with the market's opinion and allowing it to carry you to your goal.
You don't need to lead the crowd... but it helps to be close to the front of your subway so that you can get off the train in a timely fashion after being pushed to a sufficient level of profit.
So what can you do if you suffer from this particular malady, but still want to trade?

3 Steps You Can Take To Defeat Ambiguity Effect

Relax

First, relax... you're not alone. Most people avoid trading because it requires a certain level of comfort with uncertainty.

Minimize Risk

Second, take steps to reduce the adverse consequences of any wrong decision. In the case of trading that means reduce your risk exposure to the lowest level possible... always... and immediately... from the outset. In the words of Market Wizard Bruce Kovner, "Undertrade, undertrade, undertrade." That's in both size [number of shares, contracts, etc.] and frequency [how often you trade]. It will make it easier to move forward if your risk is appropriately minimized. It will also make it MUCH easier to bear the inevitable losses that come with any trading strategy.

Focus On The Aggregate

Finally, focus on your overall strategy and outcomes as opposed to individual trades... Think of your trades and results in batches as opposed to single trades. The goal of trading is to make money in the aggregate... of course, that assumes you'll perform pretty well on each trade, but if your process is strong, that will take care of itself. Combined with minimizing your per trade risk, this can, and likely will, push your trading deep into the black.

You're welcome.

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