Choice overload in trading- When less is more
Introduction
Imagine you are in a new coffee shop. There are 3 options: iced coffee, Americano and latte. What’s your choice?
Now imagine your choices are:Americano, Cappuccino, Cafe Breve, Cappuccino, Cortado, Espresso, Latte, Café Mocha, Cold Brew, Flat White, French Press Coffee Frappe, Macchiato.
What’s your choice now? You might stick with your normal order, try something new, or copy the guy in front of you in the queue. Regardless, you will definitely spend more time and energy making your decision.
The second scenario has so much choice, it overloads our brain. When our brain is overextended, we get tired and can make impulsive, rash decisions. This is known as choice overload.
Choice Overload in Traders
Let’s look at how choice overload affects traders. In trading, there is no clear path to success. It can seem every turn is filled with complicated choices that have a knock-on effect, and it is tough to determine what are the right choices with so many available. Furthermore, decisions can be very time sensitive, so traders are often not given a lot of time to mull them over.
It might seem intuitively like having lots of choice is a good thing, but the opposite is true. When we are presented with too many options, we have what is called choice overload-we are overwhelmed with how many choices are available, and make objectively worse decisions.
This is because choice overload can trigger issues such as decision fatigue, the status quo bias, or choice deferral.
Decision fatigue
Decision fatigue refers to the reduced capacity we have for decision-making after we have had to make a lot of decisions.
Our brains are amazing, but none of us are computers. Like the muscles in our body, our brain tires when we have to use it a lot. Think of it like starting with full glass of water each morning, and with each decision we make during the day, we take a tiny sip of water. We then have to make hundreds of decisions during the way day (whether to snooze, what to wear, which coffee to get, how to get to work, which email to answer first, and all that is before 9.30AM!), so by the time bedtime rolls around, we are often left with an empty glass. This mental fatigue can cause us to make ill-informed and rash decisions. If in the morning when we choose what products to trade in, we are more likely to weigh up the pros and cons and make an educated, rational choice. By the end of the day, the mental effect of choice after choice has tired us, and so we often take shortcuts with our decision making process, or just stick with what we’re already doing.
No one is above this - no matter how rational we try to be, we can’t make decision after decision without paying a price. Naturally, we get tired quicker if for each choice to be made, there is numerous options available (like at the coffee shop). That takes more of our limited brain ability to process, so decision fatigue can set in much earlier in the trading day, causing a great amount of fatigued (and potentially detrimental) decisions to be carried out. Our studies show that traders who stick to 5 products or less are 50% more likely to be successful as those who trade over 25 products. Limiting the number of products and charts available for trading decisions can help minimize decision fatigue.
Status Quo Bias
The status quo bias refers to people preferring to stick with how things already are, even if a better choice is available.
People don’t like change, so we tend to stick with the same strategy we had already. Even when a direction becomes available that is more beneficial to us, the status quo bias makes us inert and we don’t make the change. Think of staying in a gym membership when you go once a year, or sticking with the same insurance year after year. This bias can be triggered by having too much choice available-we get overwhelmed and decide to go with the safe choice, i.e. what we are currently already doing. We know this option, and feel comfortable with it, so we choose to be safe rather than taking a risk.
We’ve seen evidence of this bias in trading when we studied the behaviour of traders around the product they trade most often. For 1 in 6 traders their most traded product shows significantly more negative returns than their other products. For 1 in 8, it is actually their worst performing product. For those traders, sticking with their go to product is having a negative impact on their performance.
A way to minimize the likelihood you will pick the status quo is by reducing your choices. We are more likely to change from our current position if we’re given a selected choice, say 3 options, because we feel we can better assess the pros and cons of all. The same can be true for our trade selection process. If we are using multiple sources of ideas or signals, we can overly rely on a default source without clearly understanding if it is the most viable option.
If you find yourself reviewing a price chart with a large number of different indicators turned on, ATR, Fibs, trendlines, support and resistance lines, triangles, lots moving average etc, then you know exactly what we mean.
Choice Deferral
Sometimes when we have a lot of options available, we put off making a decision. We give our future selves the responsibility of deciding, so we can relieve our present selves of any stress. How many times have you said to yourself, “I’ll do that tomorrow” when faced with a complicated choice? This can have little consequences if the decision isn’t time sensitive. In trading, timing is key, so putting off a decision can have a big negative impact on a trader’s P&L.
Traders can sometimes defer the choice of closing a trade, because of this inertia described above, If a trader does this a lot with losing trades, their disposition will be low. They could be deferring the hard decision to take a loss.
To recap, having too much choice causes multiple negative consequences in our trading, but there are solutions to these biases.
What are the solutions to these biases?
Having too much choice causes multiple negative consequences in our trading, but there are solutions to these biases:
Decision fatigue: Trade 5 or less products, and take breaks throughout the day reset
The status quo bias: Don’t overly focus on your most traded product if your analysis shows it’s not beneficial.
Choice deferral: Measure your disposition ratio to determine if you might being deferring hard choices to close losers, causing your performance to degenerate.
Conclusion
Despite it feeling somewhat unintuitive, it is most often better to have a small number of options that are easy to understand, instead of overwhelming yourself with endless iterations of options. Beware if you always find yourself sticking with what you are already doing, and really analyse whether that is the most beneficial. And finally, try to think of your brain as a muscle- so you should take regular breaks to recharge and reset.