This is great in theory, but as you said we as traders do the opposite. I have been terribly guilty of this. Another basic trading rule to combat this that all traders should follow is to have a sound money management strategy because if you fail to plan you plan to fail.
Yep. We're Risk-Averse rather than being smart with Risk-Management. If we think logically, there's no sense in selling a profitable stock if it's been consistent. There's also no logic to keep a losing stock and thinking we can somehow recoup the losses. Minimize losses, maximize gains
Somehow reading that sentence reminded me a poker game, and in fact it's not so different, if we just know we have a losing hand we should cut our losses, we should not hope for a poker when we have nothing, are we bluffing ourselves sometimes?
Thats the single golden rule of investing, proper money management. If you can manage your money right you will be on your way to riches
This is a great thing to live by when investing. Thanks for sharing it -- it's so eloquently worded but oh so true.
Our built-in risk aversion means we'll rather take a small gain than the possibility of realizing a large loss. That is why many traders find it hard to cut losses, continually hoping that a loss will turn around and they can bank a small gain or a break-even trade. I came across a study once that explained this well. Some professors gave young children a choice: They could have one sweet or treat now which was placed in front of the child. Or, if the child waited ten minutes they could have two sweets/treats. None of the kids could wait, they all ate the one that was in front of them! Humans would rather take a small gain now than risk waiting for a larger one. This is why trading is so tough- this risk aversion is hard-wired into our brains.
Try a trailing stop-loss or build a fixed maximum retracement rule into you trading plan. For example; if a position moves in your favor you will cut it if it retraces 50% of the gain.
I had this mindset early on, but I didn't know exactly what it was called. 'Disposition effect' explains it spot on.
