The Risk of Trading: Mastering the Most Important Element in Financial Speculation

LOSS AVERSION

Let's face it—nobody likes to lose. Loss aversion risk refers to the bias that we as people are more affected by a potential loss than we are by a potential gain. Risk management professionals often probe loss aversion risk in initial consultations, and you should seek such an evaluation if your coach or other professional has not discussed it with you. How to avoid or reduce loss aversion risk is vital to trading success if you are struggling with such matters. It may cause you to hold on to a poorly performing trade or give you the desire to close a position early to guarantee you are “right.” The biggest loss aversion exposure is that of risk avoidance. Simply put, the trader's fear of loss forces him or her to bypass a valid trade opportunity provided by the markets. Some may argue that the definition includes those who stop trading during the week in order to lock in early gains.

Experts in psychology suggest trading “in the moment” without reservation. You may be happy that you had a good start to the week but need to convert that thinking toward the greater need of continuing to make good decisions in order to grow according to your business plan. There are two primary types of decisions that most often result in noncompliance with a trading plan: errors of incorrect or inaccurate action and errors of inaction. Studies have shown that inaction occurred several times more frequently than did the decisive errors. One study assessed how the average blackjack player ...