Crypto investments are the new trend, but emotions are always our enemy, and we are often ignorant. Cognitive biases, those mental shortcuts our brain takes, can mislead us, making us see opportunities where there aren’t any or ignore risks right in front of us.
This article breaks down some of the most common cognitive biases investors face and strategies to navigate them. This way, your investment choices are data-driven, well-informed, and not merely the product of psychological pitfalls.
Navigating Cognitive Biases in Your Investments
Fractional Misconceptions – Unit Bias
Sometimes, when you see a whole number, you might think it’s a better deal. But this isn’t always true. When Cardano was first introduced, its price was considerably lower than Ethereum’s.
Influenced by unit bias, some investors believed they were getting a better deal with ADA due to its lower price without always considering its potential utility or market cap compared to other coins. This way of thinking is a trick your brain plays. It’s called the “Unit Bias.”
Always check the real value(market cap, emission mechanism, etc.), and don’t get fooled by whole numbers.
Initial Information Reliance – Anchoring Bias
Your brain might stick to a price or fact when you first hear it. That’s your starting point or “anchor.” “Upon the release of a whitepaper, a cryptocurrency is projected to achieve a market cap of $1 billion.” Investors might anchor to this figure and overvalue the asset even if subsequent data suggest otherwise.
People heard Bitconnect promised significant returns. Many believed it and lost money when it failed.
When doing your research, remain objective and have an open mind. Don’t let the first thing you hear decide everything for you.
Selective Research – Confirmation Bias
Sometimes, we only look for information that agrees with our thoughts. By doing this, you might miss out on the whole story. You could make a wrong choice because you didn’t see everything. You might seek information supporting your belief in a coin’s potential growth, neglecting data suggesting possible declines.
Focusing only on positive reports about a particular cryptocurrency can lead to overlooking potential risks and negative aspects.
When the U.S. Securities and Exchange Commission filed a lawsuit against Ripple Labs, some XRP holders only focused on forums and news sources that believed XRP would come out in one piece. They overlooked the potential risks of the lawsuit, which later caused significant price fluctuations for XRP.
Chasing Past Investments – Sunk Cost Bias
Ever put money into something, and even when it’s not doing well, you still don’t want to give up? That’s you getting stuck. Continuously buying a declining asset in hopes of it recovering can result in significant losses, especially if the market indicates narratives you’ve been following changed without being aware.
After investing in an underperforming ICO, you might be inclined to buy more tokens in the hope of a price rebound, ignoring signals that the project may be fundamentally flawed. Sometimes, it’s wiser to let go.
Fear of Potential Loss – Loss Aversion
Losing $10 can feel worse than the joy of gaining $10. It’s weird but true. This fear can stop you from making wise choices. Bad news from China in 2017 made many sell Bitcoin and Ethereum quickly. But the prices went back up later. Selling an asset after a slight dip due to fear can result in missed opportunities if the asset’s fundamentals remain strong. After news of regulatory restrictions on cryptocurrencies, you might be in a hurry to sell your holdings to prevent potential losses, even if the asset has long-term potential.
It’s natural to feel this way. But don’t let the fear of losing control all your decisions.
The Trap of Now – Recency Bias
The stuff that happened most recently can seem extra important in your mind. Investing heavily in a cryptocurrency due to recent news or popularity can lead to overlooking its long-term implications. Just because something’s fresh in memory doesn’t mean it’s the most important. You might over-invest in a coin recently spiked due to media coverage without considering its past performance or long-term viability.
Dogecoin became popular in 2021, and many bought it without considering its long-term value. Don’t get carried away by the latest news. Look at the bigger picture, too!
False Confidence – Overconfidence Bias
Sometimes, we feel like we know more than we do. Thinking you’re always right can lead to mistakes. Having made a series of profitable short-term trades, you might think you can predict a token’s future price movement without comprehensive analysis.
Some made money in DeFi in 2020 and thought they could always win. They didn’t know the market trend wasn’t going to remain bullish, and they lost most, if not all, their profit.
Never get caught up in emotions and start feeling like a god without mistakes. Trade what you see in the market, not what you think.
Emotional Holdings – Endowment Effect
When you own something, you feel it’s worth more just because it’s yours. Just because it’s in your hands doesn’t mean it’s more valuable.
Holding onto a token from a project’s early days might lead to investors overvaluing it, disregarding market data suggesting it’s overpriced. Some people who bought Bitcoin early never sell because they think it will always rise.
Overvaluing a cryptocurrency just because it’s in your portfolio can lead to irrational decision-making. Check the real value, not just how you feel.
Spotlight on Success – Survivorship Bias
We often hear about the big successes but not the failures. By only looking at winners, we might think winning is easy.
Focusing on coins with historic success, like Bitcoin or Ethereum, while ignoring the countless failed altcoins can lead to bad investment choices. For every success story, there are many unseen failures.
Sold by Stories – Narrative Bias
We love good stories. Sometimes, a catchy story can make an investment opportunity seem great. A compelling origin story, like that of a coin developed in response to a social cause, might make you overlook potential pitfalls in the project’s technical details. Elon Musk posted a meme about Dogecoin, and the price surged 4% just because of that.
Stories can be tempting. A great story doesn’t always mean a great choice. Always check the facts behind the tale.
Following the Pack – Herd Mentality Bias
Sometimes, if many people do it, we think it must be right. Just because everyone’s doing it doesn’t make it the best choice. As more people invest in a popular, trending cryptocurrency, others might do so without research, potentially inflating a price bubble.
Jumping into a trending cryptocurrency because everyone else is doing so might result in buying at a peak and facing subsequent price drops. Stand on your own feet. Don’t just follow – understand and then decide.
Results Over Reasoning – Outcome Bias
Sometimes, we judge decisions based on their outcomes, not how they were made.
Investing in a cryptocurrency due to its recent good performance without understanding its reasons might not always yield positive results. Just because something ended well doesn’t mean it was a smart choice.
A cryptocurrency’s price increase after a major event might lead you to attribute its success to that event without evaluating other factors at play. Focus on the why and how, not just the result.
Misplaced Trust – Authority Bias
We often believe people because they have a title or seem like experts. An endorsement from a prominent figure in the tech industry might lead to a surge in investments in a coin without considering its actual utility or project fundamentals.
Strictly relying on advertisements or opinions from popular figures without further research can lead to uninformed investment choices. People bought “Mutant Ape Planet” NFTs, thinking they’d get rewards. But the creator took $2.9 million and gave nothing back.
Always question and think for yourself, even when listening to “experts.”
Guiding Strategies for Bias Management
Know and Question Yourself
All of us have biases. Recognizing them in ourselves is the first step. If you catch yourself making a snap decision, pause. Ask yourself why you think that way.
By being self-aware and challenging our thoughts, we can make clearer, better decisions.
Biases: Good and Bad
Every one of us has biases. They can sometimes be helpful shortcuts in a busy world. Yet, at other times, they can cloud our judgment.
A Gentle Reminder
When you’re about to invest or make big decisions, pause momentarily. Remember, it’s not just about quick wins or following the crowd. Awareness of your biases and not letting them unquestioningly guide you is crucial.
The journey of investments is filled with highs and lows. While biases might offer comfort, being vigilant and reflective can make all the difference.