15 Common Cognitive Distortions and How They Can Impact the Trading Mindset

Cognitive distortions are patterns of thinking that can lead to inaccurate and negative perceptions of reality. In the context of trading, cognitive distortions can be particularly damaging to a trader's mindset, as they can lead to impulsive and irrational decision-making.

Here are 15 common cognitive distortions and how they can impact the trading mindset:

All-or-Nothing Thinking: This is the tendency to see things in black-and-white terms, without acknowledging any middle ground. Traders who engage in all-or-nothing thinking may take excessively risky trades or avoid opportunities altogether, rather than finding a balanced approach. A losing trade still has some value if you can sell the loser. Letting it go to the moon or zero is not going to preserve capital so be sure to find those middle grounds and avoid the all or nothing thinking.

Overgeneralization: This involves taking a single negative experience and applying it to all similar situations. Traders who overgeneralize may become overly cautious after a single loss, or avoid certain assets altogether based on one bad experience. It may have bounced off resistance 7 times but that doesn't mean it will bounce on the eight touch. We might overgeneralize and just think that resistance or support always holds when that is only sometimes.

Catastrophizing: This is the tendency to imagine the worst possible outcome in any situation. Traders who catastrophize may panic and make impulsive trades in response to minor setbacks. Watching the one minute chart or the profit and loss of your trade can whipsaw your emotions and increase the emotional probability of catastrophic thinking.

Emotional Reasoning: This involves making decisions based solely on one's emotions, rather than objective evidence. Traders who engage in emotional reasoning may ignore important market data and make rash decisions based on how they feel at the moment. Gut feelings get crushed by data. Facts don't care about feelings and that includes times when it feels like a top or bottom.

Personalization: This is the tendency to take things personally, even when they have nothing to do with you. Traders who personalize market movements may feel overly attached to their trades, leading to biased decision-making. This can also lead to revenge trading by taking losses personally. The market cares for none of us so taking it personally has no basis in reality.

Control Fallacies: This involves believing that you have more or less control over a situation than you actually do. Traders who suffer from control fallacies may take excessive risks or avoid trades altogether based on a false sense of control.

Discounting the Positive: This is the tendency to focus exclusively on negative outcomes, while ignoring positive ones. Traders who discount the positive may overlook profitable trades or focus excessively on losses.

Filtering: This involves focusing exclusively on one negative aspect of a situation, while ignoring all positive aspects. Traders who filter may fixate on a single negative news story or market trend, ignoring other important data.

Jumping to Conclusions: This is the tendency to make assumptions without sufficient evidence. Traders who jump to conclusions may make impulsive trades based on incomplete or inaccurate information.

Magnification and Minimization: This involves exaggerating the importance of negative events, while minimizing the importance of positive ones. Traders who engage in magnification and minimization may become overly pessimistic in response to small losses, while failing to appreciate larger gains.

Labeling: This involves attaching negative labels to oneself or others, based on a single negative experience. Traders who label themselves as "bad traders" after a single loss may become overly discouraged and make impulsive trades in an attempt to regain confidence.

Should Statements: This involves placing rigid expectations on oneself or others. Traders who engage in should statements may become overly fixated on meeting arbitrary goals, leading to impulsive or reckless decision-making. e.g. This market should bounce, this support should hold, this should reverse.

Mental Filtering: This involves selectively paying attention to information that confirms one's existing beliefs, while ignoring information that contradicts them. Traders who engage in mental filtering may become overly attached to a particular trading strategy, ignoring evidence that it may not be effective.

Fortune Telling: This involves making predictions about the future without sufficient evidence. Traders who engage in fortune telling may become overly optimistic or pessimistic about the market, leading to biased decision-making. For example loading up on calls because the Powell is speaking or there some kind of imminent Fed meeting.

Mind Reading: This involves assuming that you know what others are thinking or feeling, without sufficient evidence. Traders who engage in mind reading may become overly focused on the actions of other traders, rather than making objective decisions based on market data.

Awareness of cognitive distortions can help traders work to overcome them and develop a more balanced and rational mindset. This can involve techniques such as mindfulness meditation, cognitive-behavioral therapy, and journaling to identify and challenge negative thought patterns.

Additionally, it can be helpful for traders to maintain a trading journal to track their emotions and decision-making processes over time. This can provide valuable insights into patterns of behavior and help traders develop more effective strategies for managing their emotions and making rational decisions in the market.