Investing in crypto is a popular trend, but we often let our emotions get the better and are unaware of the facts.
Our brain uses cognitive biases, mental shortcuts that can lead us astray, to make decisions. They can make us see opportunities that do not exist or overlook obvious risks.
This article explains how investors can fall victim to some of the most common cognitive biases that affect their decision-making. It also offers strategies to overcome them and make data-driven, well-informed, and rational investment choices.
This way, you can avoid psychological traps that distort your perception of opportunities and risks.
Different Types of Cognitive Biases
Fractional Misconceptions – Unit Bias
You might be tempted to think that a whole number is better than a fraction. But that’s not always the case in crypto. When Cardano was launched, it had a much lower price than Ethereum.
Influenced by unit bias, some investors thought ADA was a better bargain because of its lower price. They did not consider its potential utility or market cap compared to other coins.
This is a mental shortcut that your brain uses. It’s called the “Unit Bias.”
Don’t be fooled by whole numbers. Always check the real value (market cap, emission mechanism, tokenomics, etc.) of the coins you invest in.
Initial Information Reliance – Anchoring Bias
The first price you hear about a project might influence how you perceive the project going forward. That’s your reference point or “anchor.”
“A cryptocurrency is expected to reach a market cap of $1 billion after its whitepaper is released.”
Don’t let the first thing you hear determine everything about a project.
Selective Research – Confirmation Bias
We tend to look for information that confirms our opinions.
This can make us miss the bigger picture. We might make a bad decision because we didn’t see everything.
We might look for information that supports our belief in a coin’s potential growth, ignoring data that indicates possible drops.
Only paying attention to positive reports about a certain cryptocurrency can make us neglect the potential risks and negative aspects.
When Ripple Labs faced a lawsuit from the U.S. Securities and Exchange Commission, some XRP holders only paid attention to forums and news sources that believed XRP would survive.
They neglected the potential risks of the lawsuit, which later caused the price of XRP to plummet significantly.
Chasing Past Investments – Sunk Cost Bias
Have you ever invested in something, and even when it’s losing value, you still don’t want to quit? That’s you getting trapped.
You keep buying a falling asset, hoping it will recover and can lead to big losses, especially if the market shows that the narrative (bear or bull market) you’ve been following has changed, and you didn’t notice.
Sometimes, it’s smarter to cut your losses and move on.
Fear of Potential Loss – Loss Aversion
The pain of losing $10 can feel stronger than the joy of gaining $10. It’s strange but true. This fear can make you avoid smart choices.
Many people sold Bitcoin and Ethereum quickly when China announced bad news in 2017. But the prices rose again later. Selling an asset after a small dip because of fear can make you miss opportunities if the asset’s fundamentals are still strong.
After hearing about regulatory restrictions on cryptocurrencies, you might want to sell your holdings to avoid potential losses, even if the asset has a long-term future.
It’s normal to feel this way. But don’t let the fear of losing dominate all your decisions.
The Trap of Now – Recency Bias
The things that happened recently can seem more important in your mind than they are.
Investing much in a cryptocurrency because of recent news or popularity can make you ignore its long-term consequences.
Just because something is fresh in your memory doesn’t mean it’s the most important.
You might invest too much in a recently spiked coin because of media attention without looking at its past performance or long-term potential.
Dogecoin became famous in 2021, and many bought it without considering its long-term value.
Don’t be swayed by the latest news. Look at the whole picture, too!
False Confidence – Overconfidence Bias
Sometimes, we think we know more than we do. Being overconfident can lead to errors.
After making a series of successful short-term trades, you might believe you can forecast a token’s future price movement without thorough analysis.
Some people made money in DeFi in 2020 and thought they were always right. They didn’t realize the market trend was not going to stay bullish, and they lost most or all of their profit.
Don’t let your emotions cloud your judgment and make you feel like a flawless god. Trade what you see in the market. Give no room for assumptions.
Emotional Holdings – Endowment Effect
You might think something is worth more just because you own it. But that’s not a good reason to value it higher.
Keeping a token from a project’s early days might make you think it’s more valuable than it is, ignoring market data showing it is overpriced.
Some people who bought Bitcoin early never sell because they believe it will never stop rising.
Valuing a cryptocurrency too high just because it’s in your portfolio can make you act irrationally. Look at the real value, not just your feelings.
Spotlight on Success – Survivorship Bias
We often only see the big successes but not the failures. By only looking at winners, we might think winning is easy.
Only paying attention to coins with historic success, like Bitcoin or Ethereum, and forgetting the many failed altcoins can make us choose poorly when investing.
For every success story, there are many more hidden failures.
Sold by Stories – Narrative Bias
A captivating origin story, like that of a coin created for a social cause, might make you ignore potential problems in the project’s technical details.
Elon Musk tweeted a meme about Dogecoin, and the price went up 4% just because of that. Stories can be appealing. But a great story doesn’t always mean a great choice. Always check the facts behind the story.
People who bought Dogecoin because of Elon Musk’s tweet are now bagholders.
Following the Pack – Herd Mentality Bias
Sometimes, we think something is right because many people do it. But that doesn’t mean it’s the best choice.
As a popular, trending cryptocurrency attracts more investors, others might join them without research, possibly creating a price bubble.
Buying a trending cryptocurrency because everyone else is doing it might make you buy at a high price and face later price drops. Think for yourself. Don’t just follow – understand and then decide.
Results Over Reasoning – Outcome Bias
Sometimes, we evaluate decisions based on their outcomes, not how they were made.
Investing in a cryptocurrency because of its recent good performance without knowing its reasons might not always work well. Just because something turned out well isn’t a wise choice.
A cryptocurrency’s price rise after a major event might make you think that the event caused its success without considering other factors involved.
Pay attention to the why and how, not just the result.
Misplaced Trust – Authority Bias
We often trust people because they have a title or seem like experts.
A coin might get a lot of investments because a famous figure in the crypto industry endorsed it without looking at its actual utility or project fundamentals.
Only relying on ads or opinions from popular figures without more research can make us choose poorly when investing.
People bought “Mutant Ape Planet” NFTs, thinking they would get rewards. But the creator ran away with $2.9 million and gave nothing back.
Always think and question things you don’t understand, even when listening to “experts.” If you don’t have a communication channel with experts to ask them questions, do your research to satisfy your curiosity.
Strategy to Manage Cognitive Biases: Know and Question Yourself
We all have biases. The first step is to admit we have biases. Then, the next step is to recommend solutions.
If you are making a quick decision when investing, you should stop. You should ask yourself why you think that way. What conviction do you have about this?
You can make better and clearer decisions by being aware of yourself and questioning your thoughts.
A Gentle Reminder
We all have biases. They can sometimes help us make quick decisions in a complex world.
But, at other times, they can distort our thinking. Before you invest or make big decisions, take a moment to think.
Remember, it’s not just about fast gains or following the crowd. Being aware of your biases and not letting them control you is essential.
The journey of investments has ups and downs. While identifying your biases, being careful and thoughtful about your investment approach can make a big difference.