14 Common Cognitive Biases Crypto Traders Need to Avoid

Author: The DeFi Edge

Compiled by: Gu Yu, Chain Catcher

I’ve researched hundreds of cognitive biases to become a better crypto investor. Here are the top 14:

1) Unit deviation

People prefer to buy a "whole unit" of a token, rather than a fraction of it. That's why meme tokens explode. Don't inflate the value of a token just because it's "cheap". Understand how market cap works.

2) Anchoring bias

Over-reliance on the first piece of information you have. You heard about Bitcoin at $1,000. You missed it. Then it went up to $5,000. You don’t want to buy it anymore. It’s “too expensive” in your mind. Evaluate it based on its potential, not its past.

3) Confirmation bias

You only want to see the news you want to see. You only follow people who say good things about X token. You unfollow and block anyone who spreads “FUD”. When you invest, look for and research FUD to see if it’s valid.

4) Sunk cost bias

Costs that have already been incurred and cannot be recovered. We tend to keep investing more money or overinvest because we are afraid of losing our initial investment.

5) Loss Aversion

Losing money feels worse than making money. Anyone who has been to Las Vegas knows what I am talking about. Winning +$100 feels different than losing $100. Losing is painful. One study showed that the brain typically assigns 2.5 times more weight to a loss. +250 = -$100

For example, when your investment drops 50% and there is more bad news. You can close the trade and cut your losses. Loss aversion means that some people would rather wait it out. They are afraid of "losing" money by selling.

Loss aversion leads to risk aversion. There have been a few scams in DeFi and I’ve seen some people swear off investing in DeFi! Their loss means they’ll miss out on life-changing gains. Weigh the risks and rewards correctly.

6) Recency Bias

We overvalue recent information and events. “ETH price is boring. I’m going after low market cap coins” and then they get destroyed in a bear market. You can overcome recency bias by zooming out on the chart.

7) Overconfidence bias

We overestimate our abilities. We get lucky a few times and think we are smarter than we really are. The key to defeating overconfidence is a solid risk management strategy.

8) Endowment Effect

You develop an emotional attachment to your portfolio. We place a higher value on our investments because we own it. I see this a lot with ETH maximalists. They get huge gains from it and become obsessed with it. They ignore all other L1s.

How to overcome the endowment effect Zero-based decision making. “If I didn’t own this investment, would I invest in it today?” This makes your decision more neutral.

9) Survivorship bias

Brad Pitt moved to Los Angeles and worked as a waiter before becoming a movie star. Many people followed his path, hoping to make it too. What you don't hear about are the thousands of others who made the same attempt and failed.

Someone turned an $8,000 Shiba Inu into $5.7 billion. You don't hear about the thousands of people who turned $8,000 into $500. The media prefers to report on the winners, which distorts your perception of the odds.

10) Narrative Bias

Human love stories help us understand the world. Some tokens explode because of this story. Remember GameStop last year? It was a revolution against Wall Street. People invest for narratives.

11) Herd mentality bias

Investors tend to follow and copy what other investors do. They are largely influenced by emotions and instincts rather than their own independent analysis. If you have ever felt FOMO, it was probably because of herd mentality.

12) Availability Bias

You make judgments based on how easy it is to remember the information. After major plane crashes, people often become afraid to fly. However, 1 in 9,821 people die in a plane crash, while 1 in 114 people die in a car crash. In reality, planes are safer.

In Crypto, availability bias shows up in marketing. A coin may be pumped because it has great marketing. Marketing is important, but make sure it doesn’t cover up a bad project.

13) Result bias

Outcome bias is the mistake you make when evaluating the quality of a decision when you already know the outcome of the decision. Imagine going all-in with AA vs JJ in poker (in this case, AA has an 80% chance of winning), and then losing. You made a great decision, but it turned out badly. You invested $10,000 in an altcoin and it's now worth $100,000. It had a great outcome, but it was a bad decision.

Another angle on outcome bias is, imagine if a scenario was replayed a thousand times. You have to account for the variance. You can do everything right and the outcome still won’t be right. That’s life. But you should always make decisions with the best odds and probabilities.

14) Authority Bias

It’s our natural tendency to follow the leader. Once we believe someone is an expert, we believe everything they say.

How do you stop cognitive biases? Here are some strategies I use to reduce the damage of cognitive biases.

• Make a cognitive bias inventory. Every time I make an investment decision, I review my cognitive bias inventory. This makes me aware of the flaws in my thinking.

• Consider creating your own investing system. A formula can help you control your emotions.

• Keep a trading journal. I keep a Google spreadsheet with all my trades. In addition to the financial data, I also write down some of my arguments. If I exit early, I write down any problems I encounter. By the way, I plan to create a free template for you.

• Use cognitive biases to your advantage. Understanding cognitive biases means you can profit from others. Tokens with good narratives + charismatic leaders + marketing (availability bias) + herd mentality. The more adoration, the more likely you are to profit.