Thinking Fast And Slow
Unfortunately, the human brain is not geared towards the world it has created. The software that runs our brains is effectively a Model T Ford trying to cope with being on an autobahn with an unlimited speed limit. As traders, we can both see and experience this every day. The current market turmoil has caused many traders not only sleepless nights but also caused them to do stupid things simply because their thinking was not up to speed.
We come back to the point that trading is a psychological and emotional endeavour, not a financial one.
In a strange coincidence, I found myself rereading “Thinking, Fast and Slow” by Daniel Kahneman as the market became a shit show. One of the things I learned from Johann Hari’s excellent book’ Stolen Focus’ was to always have something close by to focus on, even when time was short. And Khaneman’s book was the book I had been carrying around.
What follows are some of the main points that the book reinforced in me on a second read through. Warning, there is no talk about magic indicators in what follows, just a deep dive into how our brain makes decisions.
Kahneman explores how the human mind operates using two systems of thought.
System 1 is fast, intuitive, and emotional; it reacts automatically to stimuli without much conscious effort.
System 2 is slower, more deliberate, and logical; it requires conscious effort and is responsible for complex reasoning.
These two systems constantly interact, but our reliance on System 1 often leads to cognitive biases—systematic errors in thinking that can have significant implications in decision-making, particularly in high-stakes environments like trading.
In financial markets, traders and investors are constantly bombarded with data, news, price movements, and market sentiment. Under such pressure, System 1 often dominates. This can lead to impulsive decisions based on gut feelings, recent news, or emotional responses, such as fear or greed. For example, during a market downturn, many traders sell in panic, regardless of whether their system tells them to or not. This is an instinctual System 1 reaction, rather than calmly analysing whether the system has generated a bailout signal.
Loss Aversion
The tendency for people to feel the pain of losses more intensely than the pleasure of gains. This can be seen in trading behaviour when investors hold onto losing positions for too long, hoping they’ll rebound, rather than cutting losses early.
Conversely, they may sell winning trades too soon to “lock in” profits, fearing a potential downturn. Both behaviours are driven by emotional responses rather than rational analysis.
Overconfidence
Kahneman’s research shows that people tend to overestimate their knowledge and underestimate risks, leading to poor decision-making. If you want a clear example of how overconfident people are, consider the fact that 27% of Britons believe they could qualify for the 2028 Olympic Games. Some 6% believe they could qualify for the 100m sprint.
The expression you’re dreaming comes to mind. However, this is little different from traders who buy a book, get a piece of charting software and then believe they will make 1% a day. After all, how hard could it be?
Recency
Traders with no historical context believe that today is like yesterday, so tomorrow will be like today. There is an inability to grasp that the world, particularly the world of trading, existed before you began to take an interest in it.
This leads to a tendency to give more weight to recent events, because that is all they know. System 1 drives this behaviour by quickly forming narratives based on short-term patterns.
Kahneman emphasises the importance of engaging System 2 for better decision-making. In trading, this means relying on structured analysis, backtesting strategies, and maintaining discipline through predefined rules and risk management systems. Successful traders often use checklists, algorithms, or trading journals to minimise the influence of emotions and biases.
Ultimately, Thinking, Fast and Slow offers valuable insights into the psychology behind market behaviour. It explains not only individual decision-making flaws but also how collective biases can drive market inefficiencies, bubbles, and crashes.
