By Joe Ross on Friday, 22 December 2017
Category: Trading General

It Can Look Good in Hindsight

The human mind is capable of extreme optimism. We have a strong need to win. This need can be so strong that everything looks rosy. For example, you may look backward at old charts and think, "It's easy to see winning patterns." Behavioral economists call this optimism, 'hindsight bias.' When we know how a stock price moved in the past, we think it all seemed inevitable when we look backward. For example, if you looked at a rise in stock price over the past few years, you may think in hindsight that it was inevitable. People have been positive about stocks.

Profits have been good, and of course, stock prices went up. You may have also seen the decline at times as being inevitable as well. If too many investors buy, prices were bound to go down a little eventually. The patterns all make sense in hindsight. The problem, however, is that people have difficulty seeing these patterns in foresight.

People are, indeed, too optimistic. Our thinking can be biased and self-serving. We can falsely believe that good quality setups are easy to spot, and we can convince ourselves that success is assured. But our expectations don't always match reality.

The mind is prone to bias and unrealistic optimism. That's why it is crucial to cultivate a healthy sense of skepticism. Skepticism isn't the same thing as pessimism. A pessimist falsely distorts reality to the point that he or she believes that even a reasonable plan is doomed. A skeptic is optimistic yet is also realistic. No trading plan is foolproof. You may look back at old charts and see a foolproof way to make money. But history only repeats itself when it does (and sometimes it does not), and the mind can make it all look so obvious in hindsight. The markets don't always cooperate with you. The winning trader is the person who questions a trading plan before executing it. He or she tries to anticipate what could go wrong, and thinks of ways to work around these potential setbacks. Being a healthy skeptic can be difficult at times, but the cautious optimist usually ends up making the most profits in the end.

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