Choice: Behavioral Psychology Issues in Trading

“Goodness of character is measured in loyalty to others; greatness of character is measured in loyalty to principle.”
Brett N. Steenbarger, Ph.D.

What makes the guy next door better than me? What does he know?

Consider the example:

They both work in the same company. Have the same six figure salaries. So why is one looking forward to early retirement, while the other is looking forward to the 15th and the 31st?

The individual looking forward to the early retirement understands life is a series of choices. He knows that his decisions alone determine his results. If you only look forward to the pay day of the 15th and the 31st are you not really getting the result you intended? Otherwise you would do something else right? What is that something else?

Behavioral finance is a starting point to that something else.

How Can Behavioral Finance Help Your Trading?

Consider these Q and A’s sourced from

Q. How can behavioral finance make me a better investor?
A. First, Mark Twain was right: “There’s as much human nature in any of us as there is in all of us, and hence the only safe premise on which our investment behavior can be based is the assumption that our intuitions are likely to mislead us from time to time.” From this, an important corollary follows: To prevent us from acting on wrong intuitions, we need frameworks – literally checklists or worksheets – that compel us to consider factors that, acting on intuition alone, we are likely to miss. Admittedly, some especially gifted investors can do well without such devices, but the rest of us cannot.

TurtleTrader comment: A Trend following trading system can be thought of as a checklist.

Q. What’s the most pervasive tendency discovered thus far within behavioral finance?
A. Probably myopic loss aversion, which refers to the empirical fact that investors experience more pain from a dollar lost than they experience pleasure from an equivalent dollar gained. Consequently, most choices involving losses are risk-seeking – i.e., people will gamble on the margin to avoid losing – while most choices involving gains are risk-averse.

You may also enjoy this article on investor psychology.