Pristine Quote: "Life affords no higher pleasure than that of surmounting difficulties, passing from one step of success to another, forming new wishes and seeing them gratified." - Samuel Johnson
Psychology of Risk, Gains and Losses
A study by Kahneman and Tversky showed that there is a fundamental difference of risky choices depending of whether or not the decision involves gain or loss. Let's see how you fare. Which of the following scenarios would you prefer:
(A) A gamble with an 80% chance to win $8,000 and a 20% chance to win nothing.
(B) A guaranteed gain of $6,000.
Facing a choice involving gains, 80% of people prefer the certain gain in (B). However, now change the scenario to a choice of loss:
(C) A gamble with an 80% chance of losing $8,000 and a 20% chance to lose nothing.
(D) A guaranteed loss of $6,000.
Facing a choice involving losses, 90% of people prefer the riskier gamble in (C ). This shows that there is a propensity to seek risk in the face of possible loss! The study also showed that losing a sum of money is greater than the pleasure associated with gaining the same amount (e.g., winning $10k versus losing $10k); thus, most traders' risk-taking is characterized by loss aversion. This helps explain why many traders have a tendency to close out winning trades early and to let losers get bigger.
Pristine believes that failing to take stop losses because of some irrational hope that the loss will reverse will lead to financial and emotional destruction. That's why Pristine Co-Founder Oliver Velez is more concerned with a developing trader's losses, not gains. Anyone can make money, but it's about losing the least amount, as the result of objective and disciplined trading and admitting when trades are not working as planned, that is the hallmark of a professional trader.
Have you ever been down on the day and then developed a "get even" mentality? Sure you have. You might take a trade with twice the maximum loss or take setups without the same quality pattern, for example, all trying to recoup earlier losses. This is very destructive behavior. Assume a trader is down $10,000 with 90 minutes until market close. He can stop trading or take the risk of the last few opportunities (e.g., risk another $3,000 in a risky trade with a 10% chance of recovering the $10,000 loss). You can see the probability of continuing to trade is very poor, and this explains why traders often end up with even greater losses with this mentality.
It is Pristine's view that every single trade should be evaluated on its individual merits, not referencing prior winners or losers. Additionally, being down on the day in this example has almost surely clouded the trader's objective decision making process. So it would be our suggestion not to trade for the rest of the day, evaluate the day's trades, see what worked and what didn't, then start either with paper trading or very tiny shares to "get back on the horse," as we discuss in our seminars. Good luck!
By Dan Gibby, Senior Pristine Certified Trainer (PCT), Certified Pristine Mentor, Head Moderator of Pristine's Advanced Trading Room, Member of the Pristine Research Team, and a Trader Coach. |
