Trading Psychology in 60 seconds – Regret Avoidance
Studies have found that when investors and traders avoid selling losers to avoid feelings of regret and when they do this, they often end up causing themselves greater financial harm and psychological distress.
A lot of trading psychology has been learnt through meticulous research and study, by people such as Amos Tversky and Daniel Kahneman and more recently, by Brad O’Dean. If we skim the cream off the top of their studies we find that investors and traders routinely avoid selling losers to avoid feelings of regret and WHEN they do this so that they often end up causing themselves greater financial harm and psychological distress.
Ergo, here we are looking at the CTD chart in July 2020 (CTD is listed on the ASX). It’s been on a downtrend for two years falling from $33 to $12 today. All the research tells us that if we were a buyer at $30 and are still holder today, we are doing so for several reasons. Either we are being duped into holding on by someone else, such as a financial advisor or, more likely by our internal psychology.
We avoid selling now because:
There is a financial penalty that regret avoidance has on our account. We may be holding onto a losing position for years. The position may even get worse and we may end up losing even more money. We engage in wishful thinking about exiting at a higher price and once we let do that, we become psychologically weakened when it comes to all future investments/trades. We lose out due to opportunity cost – that is the cost of missing out on other winning trades and being unable to use the money tied up in CTD because we avoid cutting our losses, freeing that money up and playing for better position elsewhere in the market.
You can avoid being a regret avoider by doing the following: accept that its ok to be wrong, accept that you will be wrong, accept that there is a financial penalty for being wrong, accept that the best financial penalty for being wrong is a cheap financial penalty, have a trading plan which identifies risk and a price point which identifies to you that you are wrong while at the same time, allows you to exit with a small financial penalty.
The audio version of this article can be heard on the Money Thief Podcast.
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ABOUT THE AUTHOR
Paul Doggett is an Australian, private stock trader and author. He can be found online at www.stpt.com.au