Common fallacies in trading
Faulty lines of reasoning that sound convincing in the moment. Each one can lead to bigger positions, longer holds or trades that should not be taken.
What a fallacy is.
An argument that feels right but does not hold up.
A fallacy is an error in reasoning. The conclusion sounds sensible, but the logic behind it is flawed.
Fallacies differ from biases. A bias is a tendency in how you judge. A fallacy is a specific wrong argument, which you can learn to spot and name.
In trading, fallacies tend to show up as reasons to hold on, to add to a position, or to expect a reversal.
Five common fallacies.
Each one sounds reasonable in the moment, which is what makes it costly.
The gambler’s fallacy.
Believing that a run of one outcome makes the opposite more likely. Five falling days do not, by themselves, make a rise due.
The hot-hand fallacy.
Believing a winning streak will continue because you are on form. It can lead to larger positions at the wrong time.
The sunk cost fallacy.
Holding on because of what you have already lost. Past losses do not change what the trade is worth now.
The “it has to turn” fallacy.
Believing a price that has moved a long way must come back. Markets can stay at extreme levels for a long time.
The narrative fallacy.
Building a neat story to explain a move after the event. The story feels like knowledge, but it may predict nothing.
Averaging down: a worked example.
Suppose you buy 0.1 lots of EUR/USD at 1.0850, worth $1 a pip in a US dollar account.
Price falls 50 pips, to 1.0800, so you are $50 down. It has fallen for five days, so you decide it is due a bounce and buy another 0.1 lots.
Your average entry is now 1.0825, on 0.2 lots. That feels better, but each pip is now worth $2.
| Without adding | After adding | |
|---|---|---|
| Position | 0.1 lots at 1.0850 | 0.2 lots, average 1.0825 |
| Value per pip | $1 | $2 |
| Loss at 1.0800 | 50 × $1 = $50 | $50 |
| Loss at 1.0750 | 100 × $1 = $100 | 75 × $2 = $150 |
If price falls to 1.0750, the loss is $150, not $100. The five falling days did not make a bounce more likely.
That was the gambler’s fallacy, and it doubled the position just as the original idea was failing.
How to avoid them.
Fallacies lose their pull once you can name them.
Name the argument.
When you hear yourself say “it is due” or “I have lost too much to close now”, stop and write it down.
Judge the trade as if it were new.
Ask whether you would open this position now, at this price. If not, the reason to hold may be a fallacy.
Set size limits in advance.
Decide the largest position you will hold in each market before the session, so a streak cannot push it higher.
Keep exits mechanical.
Place a stop-loss with every trade, and do not move it further away from price.
Common mistakes.
Where fallacies most often turn into losses.
Adding to a losing trade without a plan. It increases risk just as the original idea is failing.
Raising position size after a winning streak. Past wins do not change the odds of the next trade.
Holding a loser to avoid admitting it. The market neither knows nor cares what you paid.
Explaining every move after the event. A good story is not the same as a forecast.
Questions, answered.
What traders ask most about trading fallacies.
01Is averaging down always a mistake?
02What is the gambler’s fallacy in trading?
03What is the sunk cost fallacy?
04How is a fallacy different from a bias?
05Can I practise spotting fallacies?
Test your reasoning on a demo.
Trade with a journal on a free MT5 demo and note each reason you give for breaking your plan.
Trading CFDs on a live account puts your capital at risk and you can lose money. A demo does not.