How Trading Loss Affect a Trader

By | December 17, 2018 3:49 pm

When it comes to trading psychology, in order to be successful in the markets traders must master HOW TO HANDLE LOSS.

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.

Problems Created by Loss Aversion

Loss aversion causes you to deviate from your trading plan. Based on your Trading Strategy , 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. It takes one bad trade to ruin the profit of all the trades

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 YOU TRUST. 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

We fear loss because your brains do not assign the same weight to a 10000 loss as it does to 10000 gain. 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 a Traffic Challan.

Think of it this way, not having a relationship with someone isn’t as painful as having someone and then losing them. Our brain typically assigns 2.5 times the weight to a loss, as it does to a gain (Kahneman and Tversky, 1979).

We don’t like to lose, and statistics show the majority of humans will gamble in order to avoid a loss.

The real problem is that if you get back to “even” after gambling in this way, your behavior is rewarded. 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.

In Next Article we will discuss Managing Loss Aversion

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