You can become a better cryptocurrency investor if you know these 14 cognitive biases.
Cognitive biases are subconscious errors in thinking that can impact one's choices and judgements. There are many cognitive biases and by learning about some of them and understanding the direct implications they have on decisions made can in fact help you to become a better cryptocurrency investor. Although these biases are unconscious, there are small steps we can take to train our minds to adopt a new pattern of thinking and mitigate the effects of these biases. In this article I explain the 14 most important ones that you should definitely know.
Common mistakes made by new investors
Common mistakes that are made by many newcomers to the cryptocurrency space include:
• FOMO'ing into a coin when it is at an all time high price
• Selling blue chip coins for a random low cap alt coin that has been shilled by a random stranger on You Tube
• Losing 50% on a coin, and then proceed to lose another 45% because the investor wasn't prepared to cut their losses.
These traits are cognitive biases working against the investor.
They can be thought of as "thinking" errors, also know as "bugs in your brain".
1. Unit Bias
People prefer to buy a “whole unit” of a token or coin, rather than a fraction of it.
This is arguably why meme coins have seen an explosion in price over the past year or so.
When undertaking coin research try not to overweigh the value of a coin or token just because it is perceived as being "cheap."
Spend some time getting to understanding how market caps work.
Price per Coin Units Total
Low cap token $0.02 250,000 $5,0000
Ethereum $3,000 1.67 $5,000
1 Year Later
Price per Coin Units Total Net
Low cap token $0.005 250,000 $1,250 -$3,750
Ethereum $10,000 1.67 $16,700 $11,700
2. Anchoring Bias
Invariably there is an over-reliance on the first piece of information someone has.
You heard about Bitcoin at $1,000.
You missed out.
Then it GOES UP to $5,000.
You don't want to buy it anymore as in your head it's "too expensive'.
Evaluate the coin or token based on its POTENTIAL not its PAST price performance.
3 Confirmation Bias
Invariably new investors only seek out information that tells them what they want to hear.
They only follow people that say good things about X coin.
They unfollow and block anyone that spreads “FUD.”
When investing its a good practice to seek out and research the FUD to see if it's valid or not and never rely on 'influencers' on social media for investment advice.
4 Sunk Cost Bias
A sunk cost is one that has occurred and can't be recovered.
We have a tendency to keep investing more money or OVER-committing because we're scared of losing our original investment.
An example of sunk cost in real life:
Someone invests $10,000 into their friend's Frozen yogurt shop. Unfortunately business is doing terrible.
The friend says "I need another $5k for a milkshake machine"
There may be the temptation to invest more to "save" their $10,000 investment.
However, caution should be thrown to the wind and good money should never be thrown after the bad.
An example of sunk cost in Crypto:
Someone invests in a coin and finds themselves -70% on their original investment.
They still have 30% left.
The original 70% is gone.
The 30% could be better off being invested somewhere else, rather than hoping that the original investment bounces back.
5 Loss Aversion
Its a reality that losing money feels far worse than gaining money.
Anyone that has been to Las Vegas knows exactly what I am talking about.
Winning more than $100 does not feel the same as losing $100.
Losing is quite a painful experience.
Studies have actually shown that the brain typically assigns 2.5x the emotional energy to a loss than a win.
An example could be when an investment is down 50% and there's more bad news. The trade can't be closed and the losses cut.
Loss aversion means that some people will PREFER to wait it out.
They're afraid of "losing" the money by selling.
Loss Aversion ultimately leads to risk avoidance.
Sadly in the world of crypto there have been a number of situations where investors experienced rug pulls, especially in DeFi.
I've seen some people vow to never invest in DeFi ever again!
Their loss aversion means they could potentially be missing out on life changing gains.
Weigh the risks vs rewards properly. Be prepared to do your own research.
6 Recency Bias
We overweight RECENT information and events.
"ETH's price is boring. I'm going to chase after low cap coins"
Then the investor gets wrecked in the bear market that follows.
You can beat recency bias by zooming out on the charts. Look at the bigger picture and have a long term time horizon for investing.
7 Overconfidence Bias
We overestimate our own abilities.
We get lucky a few times, and think we're smarter than we really are.
When it comes to investing, especially in a somewhat speculative, volatile market such as crypto the key to beating overconfidence is ensuring that solid risk management strategies are employed.
8 Endowment Effect
Far too often crypto investors become far too emotionally attached to their coins or tokens.
Invariably we place a higher value on an investment just because we own it.
In the crypto space there are a lot of tribes that will defend their coin of choice like their life depends on it. ETH and Bitcoin maxis, Link Marines, XRP Army, etc....
They may have great gains with it, however they then become emotionally attached to it.
In the meantime they ignore the other innovative new projects being developed in the space.
So, how can you beat The Endowment Effect?
Ensure that you adopt zero based decision making.
"If I didn't own this investment, would I invest in it today?"
This keeps your decision making process in a more neutral position.
9. Survivorship Bias
Brad Pitt moved to LA and was a waiter before becoming a movie star.
Many people have followed his path hoping to do the same.
You don't hear about the THOUSANDS of other people who tried the same and failed.
Someone turned $8,000 of Shiba Inu into $5.7B.
You don't hear about the thousands of others who turned $8k into $500.
The media prefers writing about the winners, and this skews your perception of the odds.
Plot twist: I am Brad Pitt.
10. Narrative Bias
Humans love stories. It helps us make sense of the world.
Some coins explode BECAUSE of the story.
Remember GameStop last year?
It was a revolution against Wallstreet. People invested for the NARRATIVE.
11. Herd Mentality Bias
Herd mentality bias refers to investors’ tendency to follow and copy what other investors are doing.
They are largely influenced by emotion and instinct, rather than by their own independent analysis.
If you've ever felt FOMO, it could be because of herd mentality.
12. Availability Heuristic
You make judgments based on how easy it is to remember information.
After major airplane crashes, there's usually a fear of flying.
• 1 in 9,821 die in a plane crash
• 1 out of 114 die in a car accident
Planes are much safer.
In Crypto, the availability bias presents itself in marketing.
A coin might be pumping because it has great marketing.
Marketing is important, but make sure that it isn't masking a terrible project.
13. Outcome Bias
Outcome bias is an error made in evaluating the quality of a decision when the outcome of that decision is already known.
Imagine going all in with AA vs. JJ in Poker, and losing.
You made a GREAT decision but it led to a BAD outcome.
(AA has 80% chance of winning in this case).
You invest $10k into a small cap altcoin that is now worth $100k.
That had a great outcome, but it was a poor decision.
Another angle of Outcome Bias to consider. Imagine if the scenario was replayed a thousand times.
You have to account for variance.
You can do everything right and the outcome STILL won't be right.
But you should always make the decision with the best ODDS and PROBABILITY.
14. Authority Bias
This is our natural tendency to follow the leader.
Once we believe someone is an expert, we trust everything they say.
"They're the expert, they must be right!"
• Experts can be wrong
• Experts can have ulterior motives
How do you stop Cognitive Biases?
Well, you're already doing a great job. At least you're aware of them!
Here are some strategies I use to lower the damage of cognitive biases.
Call Them Out.
My friend bought $100 non-refundable tickets to see a show.
He had the chance to do a consulting gig that night for $500.
He didn't want to lose the $100 he spent.
I told him that the sunk cost bias was affecting his decision making.
(I'm fun at parties btw).
Develop a Cognitive Bias checklist
Whenever I'm making an investment decision, I go through my cognitive biases checklist.
This keeps me aware of my own thinking flaws.
Consider creating your own systems for investing.
Formulas can help keep your emotions in check.
Systems over Emotions
• Take 40% profit when an altcoin goes 2x in value
• Buy ETH /w fiat on the 1st of every month
• No coin can be >15% of my portfolio
• Low cap alt coins max allocation is 5%
• Must wait 3 days before purchasing a coin. Stops FOMO
Keep a trading log.
Consider keeping a Google Spreadsheet that contains all of your trades.
Besides the financial data, you could also write about your thesis.
If you exited early, write down any issues you faced.
Use Cognitive Biases to Your ADVANTAGE
Understanding cognitive biases mean you can profit from others.
A coin that has a good narrative + charismatic leader + marketing (availability bias) + herd mentality
The more cultish, the more profit potential.
Just make sure you take profits along the way and don't be greedy.