Picture this: You are in a new coffee shop. There are 3 options: iced coffee, Americano and latte. What’s your choice?
Now imagine your choices are: Americano, Cappuccino, Cafe Breve, Cappuccino, Cortado, Espresso, Latte, Café Mocha, Cold Brew, Flat White, French Press Coffee Frappe, Sparkling espresso, Macchiato.
What’s your choice now? You might stick with your normal order, try something new, or copy the guy in front of you in the queue. Regardless, you will typically spend more time and energy making your decision even if the decision you make is ultimately the same as in the first scenario.
The second scenario has a plethora of options, and too many options can overload our brain. When our brain is overextended, we get tired, which can lead to impulsive and rash decision making. This is known in behavioral finance as choice overload.
Choice Overload in Traders
In trading, there is no clear path to success. Every step is filled with complicated choices that have a knock-on effect, and it is tough to determine what are the right choices with so many available. Furthermore, decisions can be very time sensitive, so traders are often not given a lot of time to mull them over.
Each trader should identify the choices they currently have available to them:
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Do you have accounts on several platforms?
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Do you trade across a selection of instruments, and a high number of producers?
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Do you use multiple technical indicators, chart patterns, and trading strategies simultaneously for analysis.
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Do you employ a multitude of trading strategies, including day trading, swing trading, and long-term investing?
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Are you subscribed to numerous financial news sources, market analyses, and expert opinions?
If a trader is answering yes to any of the above, this abundance of choice could actually harm their performance. It might intuitively seem like having lots of choices is a good thing. However, there is mounting evidence the opposite is true. When presented with too many options, many traders experience choice overload, and often become overwhelmed by too many available choices. This may negatively impact a trader’s decisions.
This is because choice overload can trigger issues such as decision fatigue, the status quo bias, or choice deferral.
Decision Fatigue
Decision fatigue refers to the reduced capacity we have for decision-making after we have had to make a lot of decisions.
The human brain is exceptional, but none of us are computers. Like the muscles in our body, our brain tires when we must use it a lot. Picture your mental stamina as a glass of water; every decision, akin to a sip, depletes this reservoir. If in the morning when we choose what products to trade in, we are more likely to weigh up the pros and cons and make an informed and rational choice. By the end of the day, the mental effect of choice after choice may have tired us, and so we often take shortcuts with our decision- making process, or just stick with what we’re already doing, regardless of the results.
Although we may all have different thresholds, all traders are on some level susceptible to a behavioral bias no matter how rational we try to be, we can’t make decision after decision without paying a price. Naturally, we will tire quicker if, for each choice we make, there are numerous options available (like at the coffee shop). These decisions take more of our brain’s limited ability to process information, so decision fatigue can set in much sooner. This could negatively affect a traders decision making process which could be detrimental to the execution of an effective trading strategy.
In trading, limit your choices where possible. For beginners, a good starting point can be to limit the products you trade. For example, a beginner may try starting with 5 products, this number can be increased or decreased, to suit the individual trader. Measuring the results over a month, or any time period, can also be suitable to evaluate your particular trade strategy.
Status Quo Bias
The status quo bias refers to people preferring to stick with how things already are, even if a better choice is available.
People don’t like change, so we tend to stick with the same strategy we have been using. Even when another direction becomes available that could potentially be more beneficial to us, the status quo bias makes us inert and we don’t examine these other options, or their potential benefits. Think of staying in a gym membership when you only go once a year or sticking with the same insurance year after year. This bias can be triggered by having too many choices available, some may get overwhelmed and decide to go with the safe choice, i.e. what we are currently doing. We know this option, and feel comfortable with it, so we choose to be safe rather than taking a risk.
Traders often cling to familiar products, despite repeatedly achieving poor results. . By reducing the array of choices, traders can foster a willingness to consider alternative strategies and avoid the inertia induced by an overwhelming selection.
A way to minimize the likelihood you will pick the status quo is by reducing your choices. We are more likely to consider other options if we’re selecting from fewer, more select options because we feel we can better assess the pros and cons of each option. The same can be true for our trade selection process. If we are using too many sources of ideas or signals, we can overly rely on a default source without clearly understanding if it is the most viable option.
If you find yourself reviewing a price chart with a large number of different indicators turned on, ATR, Fibs, trendlines, support and resistance lines, triangles, lots of moving averages or many others then you know exactly what we mean.
Traders should continuously monitor their positions during changing market conditions. Changing market conditions may profoundly affect the performance of an indicator, and in certain situations traders may want to consider other indicators or markets that may be better suited to current market conditions.
Choice Deferral
Sometimes when we have a lot of options available, we put off making a decision. We give our future selves the responsibility of deciding, so we can relieve our present selves of any stress. How many times have you said to yourself, “I’ll do that tomorrow” when faced with a complicated choice? This can have little consequences if the decision isn’t time sensitive. In trading, timing is key, so putting off a decision can have a negative impact on a trader’s performance.
When confronted with an abundance of options, traders may defer decision-making, and pass the responsibility to their future selves. In the world of trading, where timing is paramount, procrastinating can significantly impact a trader’s performance. Traders can sometimes procrastinate on closing a trade, because of deferral inertia. A disposition rate lower than what would be consistent with a trader’s strategy, could hint that a trader has an issue with this. They could be consistently deferring the hard decision to take a loss and risk additional losses.
Making quick decisions could be risky if not based on the appropriate market research and analysis, and executed as a part of an effective trade strategy with the proper risk management measures in place.
To recap, having too many choices may have multiple negative consequences in our trading, but there are solutions to these biases.
What are the solutions to these biases?
Having too much choice causes multiple negative consequences in our trading, but there are solutions to these biases:
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Decision Fatigue: Limit the number of instruments and products you trade. Establish a cohesive and well-defined trading strategy rather than juggling multiple approaches. And finally, incorporate breaks, when necessary, throughout the day to reset
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The Status Quo Bias: Limit the indicators you use to a select few. Choose a couple reliable news sources for market information. Don’t overly focus on your most traded products if your analysis shows it’s not profitable.
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Choice Deferral: Identify which choices are time sensitive in trading. Monitor your disposition ratio to identify any patterns of deferring challenging decisions, especially when closing losing trades. Addressing this aspect can safeguard your overall performance.
Conclusion
In the intricate landscape of trading, the quality of decision-making is pivotal. By understanding the pitfalls of choice overload and implementing strategies to counter its effects, traders can navigate the complexities with a focused and strategic approach. Despite it feeling somewhat unintuitive, it is often better to have a small number of options that are easy to understand instead of overwhelming yourself with endless options.
Regularly reassess your strategies. Compare your performance to your plan and think of your brain as a muscle. It is important to take regular breaks to recharge and reset to achieving sustained trading success.