Common cryptocurrency trading fallacies and psychological traps

With many cryptocurrency speculators confident that a new bull market is emerging, I'd like to go over some standard fallacies that traders in markets often perform. These fallacies are essentially gambling fallacies but are more obscured. The beauty of fallacies is that they can trick you into believing that you are actually winning when you're not.

Note, this is written to active cryptocurrency traders, not long-term investors.

Profiting, yet being outperformed by the index

This is one of the more common fallacies that I see traders performing and falling into. Traders will often keep trading daily until they make a positive profit. They're assuming that because they're making a continuous profit that they're beating the system but this is statistically improbable, most people are not outperforming the market. How do you tell if you're one of the traders falling for this? It's simple.

Measure your net profit from trading over the longest period you have possible. Now, measure the net profit you would have made if you had simply invested all of your money in BTC or ETH or say, an index of the top 20 cryptocurrencies. How do you performn against that? Which one made the most profit, your trading scheme or your buy and hodl investment strategy?

If your buy and hodl strategy outperformed your trading strategy in terms of net profit, then you are likely falling for this logical fallacy. You are profiting from the standard movements of the market, not from your trading strategy. A trading strategy should be outperforming the market, not underperforming or matching the performance.

This is essentially an obscure way of tricking yourself into believing that your trading strategy is a winner when in reality you're actually doing worse than a simple buy and hodl investment would've done.

Remember to re-evaluate this frequently, there can be market swings and changes in which it appears as though you're winning on one day but losing on another day.

Mistaking leverage for trading genius

This is actually a paraphrased quote from "The Big Short" which dramatically documents (somewhat accurately) what happened in the 2008 financial collapse brought on by sub-prime mortgages. I would recommend watching the movie, if you haven't seen it, it's one of my all time favourites.

This fallacy is a lot like the martingale martingale strategy in gambling. In short, you're playing an exact 50/50 odds game where you double your money if you win. You start by betting $1 and then if you lose, you double your bet to $2, lose, double to $4 and so on and so fourth until you win, at which point you reset and start again at $1. Many people fall for this in their thinking when they see it like so: "What are the odds of losing 10 coin tosses in a row, 11 coin tosses, 12!?!". You're right, the odds of being wrong that many times in a row start to grow exponentially as you keep going but the problem is, so do your bets. It doesn't take long of doubling your bets until you're betting absurd amounts of money and eventually, 10 coin tosses will go against you in a row.

If you run a simulation on this betting strategy, what you'll find is that your odds of doubling your money from say, $50 to $100 with this strategy are...50%. Yes, exactly 50%, the exact same odds as you'd have if you just did an all in bet the first time. The odds of walking away with $60? 90%, but that's the key, you have to walk away with the $60 to make those odds work. Put in short, there is no way to beat the odds, they are mathematical certainties. Now onto how this works in the markets.

Imagine you're a trader who takes advantage of leverage sometimes. Let's say that you put $100 into Bitcoin and Bitcoin drops 10%, you're at $90 and you decide fuck it, short Bitcoin. God damnit, Bitcoin goes up 10% so you close your short position and you're at $81. To "make up for the losses", you decide to open a desperate leveraged long position on Bitcoin of 10x. Bitcoin continues upwards 10% more, you decide to close your 10x leveraged long position and you walk away with a good profit of 100% thanks to your 10x leveraged position and you now hold $162. You're a genius! Does that strategy sound familiar? It should.

Obviously, this is not the exact same as the martingle gambling fallacy but it's extremely similar. You up the ante until you win to offset your losses when you lose and it appears as though you've beat the system. This is similar to what people thought during the housing bubble. They were leveraged more and more and more, leveraged products on top of leveraged products, making mountains of cash and thinking they were geniuses. The problem with this strategy is that the more leveraged you are, the more exposed you are. Eventually you're leveraged so much that just one minor market correction causes your funds to be force liquidated because you cannot afford the losses anymore and you go to $0. This is essentially what happened in 2008, the entire economy was propped up on tons of leverage and just one slight correction in rates and a few mortgage defaults (people failing to pay their mortgage) resulted in a cascading collapse of the entire economy.

Conclusion

This post does not mean that people cannot actually beat the market and become successful traders. Just recognise that in all probability, if you think you're beating the market, you're probably just falling for a logical fallacy. Some people do appear to consistently "beat the market" but the numbers are tiny and not only that, people still debate whether or not it's just a convoluted form of survivorship bias when such wins are witnessed.

If you decide to do cryptocurrency trading, or any trading, keep the ideas from this post in mind and try to assess whether or not you are falling for these psychological tricks of the mind.

Originally posted at Cracklord.com