It’s been a rough couple of days for most people’s cryptocurrency portfolios. But you might be surprised to learn that some of that pain is only in your head – and that your brain could make things even worse if you’re not careful!
If you’re not already up on these psychological traps, now’s a great time to make yourself aware so that you can catch yourself when you’re tempted to act irrationally.
Feeling losses more strongly than gains
Humans, as a species, hate losing things. We hate losing things so much, in fact, that our tendency to be “loss averse” has been quantified repeatedly in scientific studies: we feel losses twice as strongly as we feel gains.
This is something you can test on yourself pretty quickly. Imagine I offer you $100 on a coin flip if the coin lands on heads, but you must pay me $100 if the coin lands on tails. Would you do it?
Most people say no. In fact, I’d have to offer around around $200 for a win before most people felt it was worth risking a loss of $100. In other words, the potential gain has to be twice the potential loss before you start to feel like the pleasure of that gain is worth risking the pain of a loss.
Another experimental example: ask people what they’ll pay for a particular coffee mug, and they’ll give you a relatively low number, like $5. But if you give them that coffee mug and then offer to buy it for $5, or even $6 or $7, most people won’t sell. It’s not that they think the value of the mug has suddenly skyrocketed, it’s that they’re hesitant to part with something they now own, even if it wasn’t something they wanted or particularly valued to begin with!
This matters in a bear market because it means that you’re probably feeling like your losses are a lot worse than they actually are. In fact, if you’ve been invested in crypto much more than a month, chances are good you haven’t really lost anything, and are still up significantly compared to your initial investment.
But even if you really have lost money, it’s important to be aware that the psychological pain you’re feeling is probably out of proportion to the actual damage. That’s just the way humans are wired. It’s not something you can change, but if you’re aware of it, you are (hopefully) less likely to make irrational decisions based on it.
Following the Herd
As much as we like to think of ourselves as independent, humans are social creatures. Virtually all of us are susceptible to the influence of others, particularly when we perceive that lots of other people are doing the same thing.
Again, this is a psychological fact that has been repeatedly confirmed with experimental data. People almost always predict that they won’t be influenced by the crowd, but they often are.
In one series of experiments, for example, people were shown a few lines and asked to judge which line was longest. It was an easy enough test that when taken alone, almost everyone aced it. But when those same test-takers were put into a group and everyone else agreed on an answer that was wrong, the test-takers became a lot more likely to put down the wrong answer themselves.
The lesson here for crypto investors: take a minute to check yourself and assess the reasons for your investment decisions. Are you selling because your opinion of a coin has changed, or are you selling because everyone else is selling? Are you buying because you genuinely think a coin is undervalued right now, or are you buying because everybody’s saying this dip is a great buying opportunity?
Anchoring Yourself to Your Buy-In
Because the world is vast and we can’t understand all of it, humans are prone to a cognitive process called anchoring: we judge things that we’re not sure about by thinking of something we are sure about, and then making adjustments based on that.
For example, what is the population of Milwaukee? Assuming you don’t know the answer to this question (and you don’t cheat by Googling it), you’re probably going to answer it using anchoring. You may know that the population of Chicago is around 3 million, for example, and guess that Milwaukee’s population is around 1 million since you know that it’s a major city, but not as big as Chicago. In this example, you’re using Chicago as your anchor and then making adjustments to what you know about Chicago (the population) to guess something you don’t know (the population of Milwaukee).
The problem is that when people use anchors and then make adjustments, the adjustments tend to be insufficient and biased in the direction of their anchor. Using Chicago, a bigger city, as an anchor for Milwaukee tends to result in guesses that are too high (the correct answer is 600,000). But if you used a smaller city, like Green Bay (population 100,000), then your guess at Milwaukee’s population is likely to be too low.
This is important in crypto investing because anchoring yourself to the wrong numbers can lead you to make illogical investment decisions. Many people, for example, tend to use their buy-in price as an anchor. On its face, this makes sense as a way of understanding your relative profit or loss, but it’s not a great anchor for investment decisions because your buy-in price has no actual connection to the fundamentals of a given token or the forces acting on the market.
For example, people are often tempted to hold a losing coin longer than they should because it’s below their buy-in price and they want to break even. That’s the trap. If you believe the coin’s fundamentals are bad and the future looks bleak, your buy-in price is irrelevant; you should sell. If you believe the coin’s fundamentals are good and the future looks promising, then you should probably hold regardless of how far you are above your buy-in price.
Missing the Forest for the Trees
This is a fun one. Watch this video carefully and count the total number of times you see a player wearing white pass a basketball.
Did you get the correct number of passes? Most people do. But did you see the gorilla? Most people don’t.
This video reflects the psychological trap of selective attention: when we’re paying close attention to one thing, we can completely miss other things, even when they’re incredibly obvious in hindsight.
This has implications in lots of areas of human life (just think about that video the next time you read about eyewitness testimony deciding a criminal case in court)! But for crypto investors, the lesson here may be that if you focus too closely on the price dip in a bear market (or the price jump in a bull market, for that matter), you might end up missing something very important.
(Note: This post and many of the examples contained within it are summarized from the excellent book Nudge by Richard H. Thaler and Cass R. Sunstein. It’s a great read for anyone interested in better understanding their human psychology and how it can be manipulated to help people make better decisions.)