The Present Bias in Trading  

Would you prefer:

A.     €220 in a year

B.     €200 in 50 weeks 

 

Would you prefer:

A.     €220 in 2 weeks

B.     €200 today 

Most people wait the extra month for an extra €20 in the first scenario, but in the second choose the €200 today. When the amount is right in front of us, we find it hard to turn it down regardless of the future benefits we could get from turning it down today. 

Both options in the above present the same situation -wait an extra 4 weeks for another €20. Classic economics tells us if you are willing to wait 2 extra weeks for an additional €20, it shouldn't matter when the two weeks are. If you pick A in the first scenario you should pick A in the second. Your preferences should be consistent. 

 

Yet in reality, they are not. Most people display a bias towards the present option. The present bias means that we disproportionately value immediate payoffs when  considering trade-offs between two future moments. 

Don’t get us wrong, we’re not against living in the moment, but the present bias can cause some undesirable behaviours that hurt your long term success in trading.

 

It contributes to a lack of self control.

blog present bias cutting winners short graph.png

In particular, if you have the present bias, you’re more likely to take any profit and run, rather than wait patiently for a winning trade to grow bigger. 

This leads to a low disposition effect (the ratio of average time spent in winning trades v losing trades), and can contribute to lower profits in the long term. 

You can reduce the present bias in trading by setting a commitment before you begin trading for the day to have a disposition effect of at least 1.2 : 1. That means for every one minute you spend in a losing trade, you will spend 1.2 minutes in a winning trade. This helps combat your instinctiveness desire to close a trade once it becomes profitable.  

To learn more about the disposition effect, watch our trading analysis video on the subject.

 
 
Marise Gaughan