In this article we discuss the loss-aversion bias, that can be quite dangerous in trading. If you remember the previous article about behavioral biases, we defined two categories, i.e., emotional biases and cognitive errors. The loss-aversion bias belongs to the first group.
So what is the loss-aversion bias? It can be summarized by this sentence “people prefer to avoid losses than to achieve gains”. Does it sound familiar?
Why does the loss-aversion bias happen? Well, as human beings we do not like to be wrong. Unfortunately, in trading and investing trying not to be wrong may be very dangerous. First, because it is impossible to be right all the time consistently. Second, because by doing so you will probably lose money.
That is why people may sell too early a winning trade, or avoid to cut losses on a losing investment. By not wanting to be wrong, they will lose money. And this is also the reason why something that was originally a short-term trade suddenly becomes a long-term investment. Don’t ever do that.
How can you mitigate the loss-aversion bias? A simple way is to use a strategy defining when to buy and sell before you even enter a trade or investment, and follow the strategy. Do it, and you will eliminate one of the main reasons for losses.