Loss Aversion by Stella Osoba
By nature, we are wired to act in certain ways when confronted with specific situations. Being aware of these types of behavioral patterns is a first step toward conquering them. Here’s a look at how we typically react to situations that arise in the financial markets.
We dislike losses far more than we like gains. This is a cognitive bias known as loss aversion. Understanding this bias and how it manifests itself in our trading decisions can help to offset some of the more harmful decisions we are likely to make as traders. Loss aversion can lead to the unfortunate behavior known as the disposition effect, where we sell our winners too soon and hold onto our losers for too long.
Studies have shown that the psychological pain caused by losses far exceeds the pleasure of a gain. This is a natural tendency of our wiring as humans. In the wild, primitive man had to be able to deal with threatening situations with far more urgency than opportunity.