Pareidolia in Trading; or seeing what we want to see

4 Sep

In trading, as in many areas of life, our perceptions are often shaped by our desires and expectations. This phenomenon, where we see patterns or signals that align with our preconceived notions, can be likened to pareidolia—a psychological tendency to perceive familiar shapes or patterns in random or ambiguous stimuli, like seeing faces in clouds or animals in rock formations. In the context of trading, pareidolia can manifest as the tendency to identify market patterns that confirm our biases, regardless of the objective data.

Understanding Pareidolia in Trading:

Pareidolia occurs when traders project their biases onto market charts, interpreting random price movements as meaningful patterns that align with their desired outcomes. For example, a trader might:

- See Patterns That Aren't There: A trader with a bullish outlook might interpret a random series of higher lows as an emerging uptrend, even if the overall market context doesn't support this view. Similarly, a trader expecting a downturn might see every minor pullback as the start of a major reversal.

- Misinterpret Neutral Data: In the desire to confirm a specific outlook, traders may interpret neutral or ambiguous data as supporting their position. This can lead to overconfidence and misguided trading decisions.

- Ignore Contradictory Evidence: Just as pareidolia in everyday life causes us to ignore the randomness of what we see, in trading, it can lead to ignoring data or signals that contradict our desired market outlook. This selective perception can be dangerous, as it prevents traders from making balanced, informed decisions.

The Importance of Objectivity

The key to successful trading is maintaining objectivity. While it's natural to have a market outlook—bullish, bearish, or otherwise—it's essential to base your decisions on the full spectrum of available data, not just the signals that support your bias. Objectivity in trading involves:

- Comprehensive Analysis: Always analyze the market from multiple angles. Use a variety of technical and fundamental tools to get a well-rounded view of the market. Avoid relying on a single indicator or pattern.

- Risk Management: Incorporate strict risk management practices. This includes setting stop-loss orders, managing position sizes, and not allowing one biased interpretation to dictate your entire strategy.

- Journaling and Reflection: Keep a trading journal to document your trades, including your reasoning for entering and exiting positions. Regularly review your journal to identify patterns in your thinking, particularly any tendencies to see what you want to see rather than what is actually there.

- Seeking Alternative Perspectives: Engage with other traders or seek out market analysis that challenges your view. This helps in broadening your perspective and reducing the influence of personal bias.

Overcoming Pareidolia in Trading

To counteract pareidolia and its effects on your trading, consider the following steps:

- Awareness: The first step in overcoming pareidolia is recognizing that it exists. Be aware of your own biases and how they might influence your interpretation of market data.

- Diversification of Analysis: Use multiple sources of information and different types of analysis (technical, fundamental, sentiment analysis) to form a more balanced view of the market.

- Challenge Your Assumptions: Regularly question your assumptions and consider alternative scenarios. This practice can help you remain flexible and adapt to changing market conditions rather than clinging to a biased perspective.

- Adopt a Skeptical Mindset: Be skeptical of patterns that seem too good to be true or that perfectly align with your expectations. This skepticism can protect you from falling into the trap of seeing what you want to see.

Conclusion:

In trading, the tendency to see what we want to see—much like pareidolia—can cloud our judgment and lead to poor decision-making. By acknowledging this bias and actively working to maintain objectivity, traders can improve their ability to make sound, evidence-based decisions. The market is a complex and often unpredictable environment, and the best way to navigate it is with a clear, unbiased perspective that prioritizes facts over wishful thinking.

P.S:

I didn't randomly choose to post this educational piece under the BTC/USD chart on TradingView.
In the case of Bitcoin, pareidolia is something I've encountered quite frequently.

I vividly remember in 2021, when everyone was eagerly expecting BTC to surpass 100k, but instead, it began to decline. The majority of analyses were along the lines of: "BTC has dropped to the 50-day moving average, it’s a great buying opportunity," or "BTC has reached the 100-day moving average, an incredible moment to buy." And then, "It's at some horizontal support, that didn’t work out, so let’s count Elliott waves—whatever it takes to justify that it will reach 100k, 500k, or whatever."

I don't claim to know whether BTC will hit $1 million in the long or very long term. All I know for sure is what the father of modern economics once said: "In the long run, we are all dead."

And no, I have nothing against BTC or the crypto market. To keep things objective, I also have something to say to those who have been predicting BTC at $0 for over ten years, or to those who have been forecasting a market crash for five years straight and then finally shout they were right when the market does drop: "The last person to predict the end of the world will eventually be right."

Have a nice day,
Mihai Iacob