Imagine if you saw it as it was, instead of what you thought it was or wanted it to be?
Over the past couple of weeks, this series of articles has looked at some of the psychological elements of trading and how they can be hidden traps for new and old traders alike.
This week, I would like to share with you the Endowment Effect and how it can influence your trading – both in decision making – and in terms of objectivity.
The Endowment Effect
The Endowment Effect is the name or label psychologists use to describe why people attach more value to things, simply because they own them. In other words, the emotional attachment that humans have with their possessions, can cloud judgement.
Some simple examples would be how we see our children, vs how they are. A good friend of mine owns a string of child care centres – if he had a dollar for every parent who said “my child wouldn’t do that”, he would be even more wealthy! My mother in law is a school principal – again – a daily phrase uttered almost universally by parents.
Alternatively, look at the process of selling a second hand car. The seller always wants more, the buyer less. The buyer (looking for a deal) the seller because they own the car and see it as special – she’s solid, very reliable, has never let us down etc!
Or how about that old footy jersey in the back of the wardrobe – faded, torn and perhaps barely fits, these days, yet you could not bare to part with it… Why – the emotional attachment from the Endowment Effect!
So how does the Endowment Effect impact on trading?
Trading successfully is about being able to make informed and objective decisions – not getting caught up in the emotion. How many times have you been holding a trade that is going against you and the inner voice in your head keeps telling you to wait another day, to see what happens… Very dangerous.
Alternatively, falling in love with shares and never wanting to sell them. Take Telstra for example, which at one point was trading above $9.00. People held on and held on (it does have a great dividend) but had it been bought and sold over that time, almost certainly you would be better off.
Key trader tips
One of the key trader tips I share with all graduates, is about trade objectivity. Make the decision on where to get in and out and where to place your stop BEFORE you get in the trade. At that point you have no emotional buy in, and can be more objective – precisely what you want.
All too often when coaching clients, I hear the same story – I knew I should have done X, Y or Z but didn’t. Generally, the cause of that indecision is the endowment effect. It can be an easy trap to fall into – but at least now you know about it!
Beware, it is not the only trap!
The market is full of challenges, particularly for the inexperienced or uneducated. However, that is just the market. Trading is as much a mental game, as it is trading process and acquiring and applying the tools to safely navigate the market requires training.
Help to tackle the markets
If you have found these articles useful and would like some help on tackling the markets without emotion, and instead, a laser sharp precision, REGISTER YOUR INTEREST HERE. Afterall, the best way of crossing a minefield is to walk in the steps of those who have safely crossed!