Colin had been watching the S&P e-mini futures all morning, waiting patiently for a trade. Finally, he saw one setup. He looked carefully at both the price action and the indicators he used to qualify his trades. Everything met his criteria. Price had turned bullish and all indicators were signaling long. “There's no flaw in the setup,” he thought.
The trade started working almost immediately. The market moved up smartly, breaking a nearby resistance level and then moved into “clear air” where no other resistance was located. The S&Ps rallied for twelve points from the trade entry—an excellent intraday run for this market. But, Colin was not on board.
He didn't take the trade. When discussing this later, he said, “The same setup occurred yesterday. I guess I was thinking of that trade, which I took, but it didn't work out. I had a loss. There was even a slight difference in favor of today's trade. One of the indicators did not confirm yesterday. Today's setup was picture-perfect. I kicked myself for not taking the trade. I don't really understand why I didn't take it. I wasn't feeling any big emotions; I certainly wasn't fearful. I just thought that since yesterday's trade failed, this one would, too. I was wrong. Why didn't I take the trade?”
What failed Colin was not his emotions or misreading the market. What failed Colin was his thinking. Colin's mind entered a natural mental blind spot psychologists call the recency effect. The recency ...