As a social species, it’s not a surprise that you’d rely on others to survive and thrive. Even when human interactions moved online, people remain social through social technologies and channels available today.
What are the odds that you tap into your network or online community to seek advice and guidance from other traders? The rise of social trading is proof that traders interact and collaborate with others for one reason or another.
There’s really nothing wrong with doing this. The problem only arises when your trading decisions are influenced by social proof bias.
What is social proof?
In his book Influence: The Psychology of Persuasion, Robert Cialdini clearly describes social proof as the assumption that “if a lot of people are doing the same thing, they must know something we don’t.”
Think about it, if you see a long queue in front of a restaurant, a common assumption is that the food must be good. Otherwise, people won’t be willing to wait in line.
However, Cialdini also pointed out that because the crowd is acting on its collective knowledge, there’s no superior source on which their decisions are based. What’s happening is that they’re reacting on the principle of social proof which can result in mistakes.
How can social proof bias affect your trading decisions?
It will affect how you make decisions and take responsibility for them.
Because you turn to other traders for advice or follow what most of them are doing when you’re unsure, you could end up:
- Losing confidence in your skills and knowledge
- Deviating from your trading plan, even when it has proven effective in the past
- Following other traders when the strategy you use and your goals are different from theirs
The worst of all is that you rely on someone else to make decisions rather than take responsibility for your actions. When something goes wrong with the trade you make, you’ll only have yourself to blame.
How can you overcome social proof bias?
- Acknowledge that social proof bias is affecting your ability to decide independently so you can suppress it and achieve better outcomes.
- Value independent thinking the same way Warren Buffett does. Read, research, and analyse on your own rather than rely on what the majority do, think or feel.
- Get your own conclusions based on the data and information collected. Most seasoned traders and great capital allocators will not rely on analysts or estimates of upcoming earnings to make a decision.
- Trust the data when you’re unsure or worried that you’re wrong and the consensus is right.
Most importantly, don’t rely on someone else and take responsibility for all your actions.
Social proof bias is just one of the many trading biases you might encounter and need to overcome. Traders are also susceptible to confirmation bias or the dangers of recency bias.
It’s likely that we’ll be influenced by psychological/cognitive biases because of how our brains are hardwired. But you can better deal with them when you know what they are and how to get rid of them.
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