Loss Aversion and the Relation to Our Lives

Many of you may know that my actual profession is as a trader and financial market analyst.  Philosophy and  psychology are my other prominent interests, and the lines between these two areas of my life definitely intersect… often.  An example is the following article I sent to subscribers within my Vantage Point Trading Newsletter which is sent out each week and covers what is going on in the financial markets and also insights into how traders/investors can be become better at what they do.  So with that said, the following is exactly as it was sent.  It was addressed to my “trading” audience, but the principles apply to all aspects of our life, as I point below.    So I pass this along to you as I think it is a very powerful concept.  If the trading examples don’t make sense, don’t worry about it.  Hopefully some of the other examples will resonate.

Enjoy…

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Has there ever been a time where you couldn’t accept that you were losing at something?  Admitting the loss, realizing it and taking the “bumps” was just too much?  Moving on doesn’t seem to matter in those times, it is just about getting back what you had (or even attaining a part of what you expected when you started the journey).  Holding on and not admitting defeat almost seems like the logical thing to do…but it is a disaster waiting to happen.

I am not just addressing trading here.  Have you ever had a relationship which was not going that well…but you stayed in it anyway, hoping it would get better?  Have you stayed in a job you hated?…Convincing yourself that you stay because one day you will “grow” to like it?  This is loss aversion, it is an unwillingness to accept the things in our life we don’t like.  We expect (or really really want) them to change…and so we hold on to them thinking the things we already have will change.  When put this way it sounds very illogical, but we all do it at times.

Bosses keep poor employees around because they don’t want to fire them.  Most likely the employee doesn’t like the job and is only there because they are holding on waiting for something better.  That something better never comes along for the employee because they are stuck in the dead end job, and nothing better comes along for the boss because he is stuck with a dead end employee.  Ouch!  Have you ever considered this before?  Life is riddled with examples of how loss aversion keeps us from achieving goals.  And it is on both sides of many issues.  When we don’t admit the reality of our current situation, nothing will ever change.

Contrary to what many might think, and this is just my opinion based on my own observations, it is not from a lack of taking risk that people don’t achieve their dreams.  Rather it is that they fail to fully accept that what they are doing right now is not working.  Think about that for a moment…

Great traders, and those are successful in life in general learn to confront their demons head on.  They see that holding onto (or staying in) a negative situation (or bad trade) will only result in disaster (disaster being we never get to see what we are truly capable of).  They (successful traders) see that trying to “get back to even” on that increasingly losing trade is illogical.  It is a loser and funds/resources/time should be invested in something else which is showing progress.

Let’s go back to the taking risk idea, and how I don’t think it is the reason we fail.  Traders most definitely take risks everyday, but so does everyone.  We go outside, drive cars, eat food that could be pretty much anything these days, we meet people, we date people, we don’t meet people, we don’t date, we don’t go outside, we work, we don’t work….almost everything is a risk in some way and  in some sense.  Granted there are some risks we are more comfortable with than others, but we still take risks…all the time!  And the way the sensationalist media portrays it we should all be dead anyway…everything is bad for us!  Hmmm, and yet we are all still here trying to make our personal worlds the best they can be….

What will separate people that excel (trading included) is the ability to look at a situation and say “this is not working, and I am moving on to something else.”  This does not mean we flip-flop around from idea to idea, we give something our best effort, but when it doesn’t work we admit it.

Seems easy, but why is it so difficult?  There is a bit of psychological science behind it.

A study found that on average peopled viewed a loss as having 2.5 times the impact as a gain of the same magnitude (Beyond Fear and Greed, H. Shefrin – page 24: one of the most fascinating books I have ever read).  Making $100 is just making $100….but LOSING $100 on something had a psychological impact of losing $250!  Think about what this means.  All of a sudden we have a very strong emotional drive to not admit the loss.  To admit the loss is to feel like we have lost much more than we actual did.

So what do we do…we hold on, not wanting to have that feeling.  And then what happens?… the trade keeps getting worse, losing us more and more money until we eventually hit the “I don’t even care any more” stage.  This is where we give up, blame the market, eventually exit the trade and repeat the process in other areas of our life.

Ultimately it comes down to a bit of self-inflicted-tough-love.  You need to tell yourself that this is not working out and efforts are better placed in another endeavor (trade).  We may not want to take a loss (or get out of a losing situation) because we don’t like the feeling of being wrong.  But just try it, or think of a time you admitted you were wrong.  It was not that bad…in fact it was likely liberating!  Your spouse loved it and showed it, your career got better because you started coming up with better ideas and decisions because you were not stuck on old (non-working ideas), your trading improved because you were willing to get out of losing trades before they got out of hand.

Take pride in being someone who accepts and admits that something is a losing cause.  It takes dignity and shows that you respect yourself and everyone else who is impacted when you do this.  Learn to enjoy it.  Hurdles and choices such as these are not meant to stop you…they are meant to stop everyone else.  The truth is we can all get to the point that we want, but we must first accept our present reality, admit it is isn’t working for us (whatever area of life this applies to), cut the cord and simply say “Next!”

Have a wonderful weekend,

Cory Mitchell, CMT

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Even though it was originally written for my finance audience, hopefully the relevance can seen in other areas as well.  This is not a trading concept, it is a life concept which I have applied to trading.  Understanding this and just saying, “I was wrong…and now am moving on”  is a life changing moment each time we say it and act on it.