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Chapter 5 Hindsight Bias (Exaggerated sense of predictability in retrospect)

Hindsight bias is a psychological phenomenon that makes past events seems more obvious at present than while they were actually taking place. Hindsight bias makes us believe an event was far more predictable than it really was, resulting in an oversimplification of the reasons that caused the event.

It is easy to explain once something has happened why it was so obvious, by simply collecting past data and fitting it in the present scenario.

Hindsight bias is experienced by almost everyone in their day to day life and even while trading.

Once an event has gone by, we tend to trick our mind into believing that we knew exactly what was going on and that we were in control of the situation the entire time.

Hindsight bias in markets

Very often while trading; analysis about the market through charts, fundamental data and indicators give mixed pictures of the current situation at hand. However in hindsight traders tend to look back at market outcomes and selectively pick out positive data that would predict the market movement. They behave in a manner that they had knowledge of the market movement all along.

For a trader analyzing historical charts; trading appears simple; the ideal levels to initiate a trade and exit appear obvious in hindsight. This generally tends to give a false sense of confidence that such trades could be initiated in real time. But as we know trading happens in dynamic markets rather than on historical static charts which requires us to take quick decision even when all the signals are not clear sometimes.

In the above chart of Nifty, a trader performing post event analysis would easily identify multiple attractive trades having low risk and high reward. The trader could have initiated any one of the trades either to buy or sell and made money.

But initiating such trades is not easy,

  • Traders may have to place the trade when signal and indicators are not clear on the chart.

  • Obtain data /information from multiple sources which many not all align together.

  • Has to place the trade without getting swayed by the view of news anchors and colleagues.

  • Has to initiate the trade at the correct levels in order to get the desired risk reward ratio.

  • Has to overcome his physiological trading barriers such as fear, greed, regret etc while trading.

  • Has to decide when to exit the trade.

Placing a trade, overcoming all the above barriers requires experience and skill on the part of the trader which is not easy to come by.

Avoiding /Tackling Hindsight bias

Traders often experience frustration and regret in tandem with hindsight bias. This stems from the fact that a trader feels that he was not able to participate in a trade, which he knew was bound to happen. He gets a feeling of having missed out and in order to overcome this guilt feeling he tends to overtrade which usually leads to major losses.

Another feeling experienced by traders is overconfidence. A trader analyzing historical charts gets a feeling that he would be able to predict the future in a similar manner leading to trade on leverage which intern could lead to the trader’s capital getting wiped out.

It’s important that a trader sticks to his original trading plan and maintain a record of his trading decisions. Post analysis of the trade in an objective manner taking into consideration the information at hand at that juncture helps overcome hindsight bias to an extent. A trader should capitalize on trades within his domain rather than trying to capture every single trade.

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