Why You Should Be Wary of "Certainty" in Trading

When an asset market is in a strong uptrend or downtrend, some traders become "certain" of their beliefs in an otherwise uncertain financial market. In other words, they place bets thinking the asset will rise forever, or only ever fall.

However, most assets go through repeated rises and falls over the course of a market cycle. At times, some indicators such as the RSI (Relative Strength Index) may reach extremes close to 0 or 100, but even then, a pullback eventually comes.

If you want to succeed as a trader, you need to be careful about being "certain" of anything. In this post, we'll look at the dangers of the "certainty" and "cognitive bias" that some investors fall into, along with how to recognize them.

Why You Should Be Wary of Certainty

The reason certainty is dangerous in trading and investing is that it is closely tied to "cognitive bias" and "confirmation bias." These biases lead you to overestimate your own beliefs and knowledge, and trap you in the error of thinking that your view alone must be the right answer.

What happens if you can't see the market objectively and cling to your own perspective with a narrow view? Problems arise when the market reverses, or when new external variables appear that differ from before, such as regulatory or policy issues.

Successful, experienced traders know how to admit they were wrong and "cut their losses" on the positions they hold when the market moves differently from what they expected. Most beginner or intermediate traders, however, say "Let's just wait a little longer" even in these situations, and end up taking big losses.

Watch Out for "Always" and "Definitely"

As you invest, you naturally come across opinions from the community, and you often end up going along with the general public opinion without even realizing it. A useful heuristic in these moments is to pay close attention to periods when investors frequently use words like "always" and "definitely."

The financial market is full of uncertainty, so being certain of anything here is a very risky choice. To survive in the market, you need to manage risk properly and be able to invest and rebalance somewhat mechanically, following logic rather than emotion.

If someone says "That will never happen" or "This is a sure thing," or if you find yourself thinking that way, be careful. Also, watch out when the community is flooded with people showing off their profits. This is the so-called "human indicator" signal, and it often means the market is near a top.

Closing Thoughts

It's not hard to find cases of traders who built up great wealth, only to lose everything in just a few days or weeks. These are cases of failed risk management, and behind them there was often a misguided "certainty" of their own.

If you want to succeed as a trader and investor, it's important to develop the ability to recognize this kind of cognitively biased certainty and keep it in check. Don't forget that the key to success lies not in "how much faster and how much more you can earn," but in "risk management so that you don't lose."