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7 Strategies to Overcome Loss Aversion Bias in Day Trading

Loss Aversion Bias

Why is it that a trader can do well on Demo and then fall apart on Live. Or when they pass their prop firm challenge and then the spotlight is on them, they clam up, protect themselves, become extremely conservative, change strategy, etc and ultimately fail?

What’s happening? And how do we overcome it?

A bias stemming from prospect theory may be in play – Loss Aversion.

Loss Aversion is a psychological and economic concept, which refers to how outcomes are interpreted as gains and losses where losses are subject to more sensitivity in people's responses compared to equivalent gains acquired.

OK great! So, what.

Let’s break it down – Humans are attached to their emotions AND, when under stress we revert to our “reptilian brain” Unfortunately this results in a knee jerk reaction. It’s an automatic and almost instant protective mechanism. It is seen as an inherently instinctive survival operation built from thousands of years of evolution.  

Think of any animal when under threat – what do they do? A cat jumps, an Elephant stands it’s ground, a Gazelle runs, fast!

What do you do when your hard-earned money is at threat?

Let’s take a scenario (Day Trading). - A trader enters a trade, and it moves against them, and they feel the pain of a full loss as soon as they enter. They compare the loss in dollars$ to the value of their rent or that they could have had a holiday Bali for that level of loss. Their comparing the loss to value in their real life and that hurts!

At this point they have forgotten the reason why they entered, and they’ve forgotten the feeling of the profit or what the “unemotional” intension is. They’ve slipped into the reptilian mindset.

They doubt the decision and look for a reason to exit, moving to lower timeframes to protect, find a TA reason that it won’t move. And, when it does move against them, they then look for all the reasons to exit because they have now decided that it’s not right. Take a small loss only to find later that it moved all the way to the original target.

FUCK! - Crack the shits and slam the lid of the lappy closed.

If you’re feeling me right now, you’re not alone. All traders who are serious go through this. The ones who say they haven’t are delegitimising and have cognitive dissonance (a topic for next time).

Let’s get some perspective!

You’ve embarked on a tough gig. Not only do you have to get a system that has a probability in your favour but you also have to get the right psychology and behaviour!

Challenge accepted!

We all know the adage, and I harp on about this all the time, “let your winners run”. Easy to say right! But this devil of mine, the reptilian brain, my emotion and my instinctive protection looms - all the time. How can we change this, how do we get rid of it?

Not easy. It can happen - But it takes work!

I found a quote from a book I highly recommend: “don’t personalise the market”.

I mentioned it in my last blog, it’s titled: “What I Learned Losing a Million Dollars”

Some key points here are: 1, emotions are neither good nor bad; they simply are. 2, if you’re in the market to achieve an emotional high then you need to re-examine your choice. 3, win and loss are not associated to right and wrong.

We talk about this and dig deep in training with our traders… and I could be here all day if I continue. But let’s get to some points to start working on dissociation with money which can shut down Loss Aversion.

Ways to avoid

  1. Count in points or pips not dollars.

  2. Focus on the long term and trade the trade regardless of outcome.

  3. Have a book of successful trades to remind yourself of achievements - correct process.

  4. Have a book of trade to remind yourself of painful trades where you didn’t follow the process.

  5. Before you start the trading session, remind yourself (meditate on) what the right process is during the trade.

  6. During a trade set the SL and TP and walk away. Don’t look at it.

  7. Put yourself in stress situation and say out loud your process… “let winner run to TP, manage stop”.

Easy to say but discipline and accountability is needed to achieve this. These points need much more explanation and practice, but I hope it starts to help.

Reach out to me if you want to discuss.

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