For years, I was losing money because I didn’t get it. Not really. You hear it everywhere, it’s probably the best-known trader’s mantra in the world:
Cut Your Losers Fast And Let Your Winners Run
But most of traders are unable to implement the same in their trading. Today we will discuss the reasoning behind it.
Loss aversion is being unable to accept a loss once in a trade. You tell yourself you’ll get out if you lose a certain amount, but just before getting stopped out you decide to hold onto the trade and let the loss grow. It is an unwillingness to accept and realize a loss; instead the trade is held, in hope that it will swing back in your direction.
GO Back to your trading logs and observe your results . You will often find Trades where you were having a 5000/- Profit You booked quickly and Traders where you were having a Loss of 5000/- You kept on holding it “HOPING” it will swing back in your direction. Studies showed that people prefer gambling for a 75% chance to lose 100, and 25% chance to keep it all, rather than losing 75 sure, and keeping sure 25. In trading, it is gambling your stop loss. In fact, the option to gamble in this example occurs only if there is an inevitable loss approaching.
When it comes to Successful and Profitable trading traders must master loss aversion.
Problems Created by Loss Aversion
Loss aversion causes you to deviate from your trading plan. Based on your method, you know that you will win about 60% of the time, just as an example, and that your method produces a certain amount of profitability after each week or month of trading (accounting for winners and losers). The problem is, by not adhering to risk management rules, and letting a trading loss grow, losses become bigger than originally calculated. Those additional losses, even one each week, can turn a profitable system into an unprofitable one. 20% of Loss Burn your trading account and if you are doing derivative one bad trade can wipe of whole year of profits or more.
With leverage, one loss which is allowed to keep running can clean out a whole account.
The bottom line is that you should be trading with a plan that has some sort of positive track record. None of us likes to lose, but by succumbing to loss aversion our plan is thrown out the window. The trading method is no longer calculated and results will likely be poor or inconsistent at best.
Trading Psychology – Causes of Loss Aversion
Fear of loss occupies a trader more than euphoria of gaining does.We fear loss because your brains do not assign the same weight to a 100 loss as it does to 100 gain.
In Layman term The happiness at finding Rs 100 on the street doesn’t equate to the frustration of opening your wallet and realizing you lost Rs 100 you needed to pay for something. Our brain typically assigns 2.5 times the weight to a loss, as it does to a gain (Kahneman and Tversky, 1979).
Many traders let there losses run and few of traders come back in profit and your behavior of Holding a Loser is rewarded even though it was a wrong trade against your trading plan This happen 1 out of 10 times and reaming time it goes against you, causes a big whole or complete blow off trading accunt. You did the wrong the thing (you went against your trading plan and your stop loss rules) and it worked out. But most of the time it won’t. It’s a trap, and it lures in new traders and casino gamblers alike.
Few examples of loss aversion in the stock market:
- Investing in safe options like FD with a lower return (say 7.5%) even though better alternatives with higher yields (12-15%) are available like mutual funds.
- Selling a good stock just because its price is higher than what you paid and to lock in quick profits, Many readers would have gone through this situation many time.
- Not willing to sell your loser stock below the buying price because you do not want to take a loss. Traders who are still Hoolding UNitech ADAG JP Associates
What is the cure for loss aversion?
Loss aversion is the default mode of most people, as it is from any psychological trap. The unfortunate part is that there is no easy fix for loss aversion. Its just like Quieting smoking.However, if you do not want to lose different opportunities to make money, then you need to get over this syndrome.
- Controlling Your Emotion: You have a small kid you are doing an important work and he comes an spill water on your work, Your Immediate reaction will be to Scold him but don’t act on it. Instead you remain present, compose yourself and just pass over the situation. Similarity in Trading you do not need to fight market and accept the fact losses are part of the game and i need to take them in my stride. WIll Require lots of Practice and we have develop some strategy in our new program.Know there will be a strong compulsion to let a loss mount because you don’t want to realize/book the actual loss, due to ego or some other reason. You will feel these things. Admit it, and try to continually bring yourself back to your trading plan, letting the plan play out.
- Have a Plan: If you get into a trade and don’t know how you will handle it if it moves in your favor, against you, or does nothing, then you shouldn’t be in the trade at all. You should follow your trading strategy That plan must provide details on how you will enter and exit positions, and then you must follow that plan no matter what sort of emotions you face while in those trades.This is possible when you back test your strategy and have trust on it.Take your loss when you are supposed to; stick to the script. That’s the only way to realize the profitability of your system.
- Practice Practice: Practice discipline and following your plan by letting the price hit your stop or target, that is it. Only when that discipline is firmly entrenched should you consider more elaborate strategies or attempting to mange each trade according to a plan.Planning well and following through. So, when executing a trade, prepare stop losses, prepare targets and just sit back and practice for a year, for months. If your strategy is good, you will see that managing loss aversion this way helps to go through your trade to the end. If the strategy wasn’t good from the beginning, you will be able to detect the mistakes. But if you interfere with your trades, you won’t be able to detect the rights and wrongs.