Losing by instinct

Discussion in 'Psychology' started by Tea, Oct 19, 2003.

  1. Tea


  2. funky


    great article! i just asked my girlfriend the same question....would you rather take a 100% chance of $3k loss, or a 80% chance of $4k loss? and would you rather take a 80% chance of a $4k gain, or a 100% chance of a $3k gain......

    amazing but it perfectly describes many trader's problems.....not that they can't admit when they are wrong, but they DON'T LIKE LOSING. so they tighten their stops, jump out at the wrong times, etc.....
  3. Tea


    The whole phenomena of moving your stop to "break even" is an example of this - even if statistically it may make more sense to move your trailing stop to where you have a small loss.

    Its vanity.

  4. Quote from Htrader:

    I completely agree and could probably write pages about this, but instead I'm going to focus on a particular example.

    Psychologists have shown that when it comes to risk and money, a normal human is subject to two factors: 1. law of diminishing returns, and 2. law of endowment

    1. law of diminishing returns - the utility you place on gains decreases as your gains increase. So you gain more utility from winning your first $1,000,000 then you do from winning the next $1,000,000.

    2. law of endowment - Your marginal loss in utility actually decreases as your losses increase. So its hurts to lose that first $100,000. But the marginal pain from losing that next $100,000 is less than from the first.

    As it relates to trading, this means that when a normal person has a very good trading day they tend to back off and protect those gains, since their expected utility from even more gains is less than what they would lose in utility should they give some of the money back.

    On the other hand, when a normal person has a losing day, they try and try to make it all back, taking increasingly larger risks. Why? Because each additional loss means less and less to them on a marginal level.

    Now ideally, a top trader should do the exact opposite. Place more utility on ever increasingly large gains, and be very sensitive to additional losses. So on a day when you are doing well, increase your size and risk tolerance, since you obviously are in sync with the market, and push your day for all its worth. On the other hand, on days when you are suffering losses, decrease size and risk, and rather than focusing on making all your money back, just try to keep ADDITONAL losses to a minimum.

    All of this is just one small example, but I find it very interesting.