Last week’s article on BHP prompted a number of comments, particularly in regards to my view on risk and return. Having had a few weeks off the trading floor – literally – as I have had some leg surgery – albeit not time away from the market.
Being off, has allowed for a bit more time to read and one of my favourite authors, Malcolm Gladwell has featured strongly in the past few weeks. He is a master as observations and consequences of social science and psychology – I cannot recommend him strongly enough.
What the Dog Saw – Trading Experiment
In What the Dog Saw, the following trading experiment, conducted by Kahneman Tversky, is discussed and I paraphrase:
A group of people are told they have $300. They were then given a choice of either receiving another $100 or instead, tossing a coin, which if they guessed right get another $200, or if wrong they got nothing. Most people picked the certainty of the $100 rather than the potential for $200.
The experiment then went on to introduce an additional variable. This time, they were given $500 and then asked if they would rather give up $100 or alternatively toss a coin and pay $200 if they guessed wrong and gain nothing if they guessed correctly. This time, the majority elected to toss for the potential to keep or lose the $200.
The observation from this – despite the probabilities being equal for all outcomes, we generally seem more comfortable to gamble when considering losses, but are far more risk averse when it comes to our gains!
It’s funny how we see risk and more importantly, how it influences our decision making – and I might add, not always in a great or positive way.
How to deal with Risk and Risk Management
Learning how to deal with risk and risk management, and then becoming comfortable with – even embracing risk – is the key to peace of mind and ultimately success, when it comes to trading and investing. Until as a trader, you become comfortable – expert in fact – at exposing yourself and your account to risk, you will be frustrated, stressed and ultimately not take trades that perhaps you should. The great news is, that this, like anything is a learnable skill!
We have a second part to this series next week.
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