The Recency Effect – How it affects Trading

Raj had been watching the Nifty futures all morning, waiting patiently for a trade. Finally,Nifty came near His entry levels based on his trading system. He looked carefully at  the price action  he used to qualify his trades. Everything met his criteria. Price had turned bullish and  signaling long should be taken. “There’s no flaw in the setup,” he thought.

The trade started working almost immediately. The market moved up smartly, breaking a nearby resistance level and then moved in his direction. The Nifty rallied almost 60 points from the trade entry—an excellent intraday run for this market. But, Alas!!  Raj was not on board.
He didn’t take the trade. Why ??

This is what he wrote in his trading journal

“The same setup occurred yesterday. I guess I was thinking of that trade, which I took, but it didn’t work out. I had a loss.  Today’s setup was picture‐perfect. I kicked myself for not taking the trade. I don’t really understand why I didn’t take it. I wasn’t feeling any big emotions; I certainly wasn’t fearful. I just thought that since yesterday’s trade failed, this one would, too. I was wrong. Why didn’t I take the trade?

 

What failed Raj was not his emotions or misreading the market. What failed Raj was his thinking.

Raj ’s mind entered a natural mental blind spot psychologists call the recency effect .

This bias is a part of the serial position effect, a term coined by German psychologist Hermann Ebbinghaus. According to this effect, the position of a particular item in a given list determines the likelihood of it being recalled. We tend to remember either the first items in the list (primacy effect) or the most recent ones (recency effect).

The recency effect is a cognitive bias where our mind weighs the latest information with greater importance than other data when making decisions. In Raj’s mind, yesterday’s outcome weighed more heavily than today’s “picture‐perfect” criteria, leading him to shun the trade.

Many traders believe emotions are the most important aspect of trading psychology. This is only partially true. Feelings and emotions are certainly important. Traders cannot make reliable decisions without them. Strong emotions such as greed, anger,
and especially fear can significantly influence trading and cause erratic trading behavior.

However, emotions are not the only thing that can influence trading. Thoughts and the way we think also play a significant role. Sometimes, thoughts ignite strong emotions and thinking almost always amplifies them. At other times, as we see in Raj’s case, emotions play little part in poor trading decisions. Less familiar to many traders is the role that our mind and our thinking plays in trading and the way we make trading decisions.
Our thinking can create mental blind spots that can shackle us, as the example with Raj shows, rendering technical skills useless at that moment. In fact, how we think and how we treat our thoughts are the most important aspects of trading psychology. So as a trader more aware you are about your thoughts  will play a vital role in your trading success. So make sure Recency effect do not affect your trading.